[No. 34738-5-II. Division Two. July 24, 2007.]
[1] Taxation — Deductions — Relationship. In general, taxation is the rule and deductions are exceptions to the rule. [2] Taxation — Deductions — Construction — Narrow Construction. Tax deductions are narrowly construed. [3] Taxation — Deductions — Burden of Proof. The taxpayer has the burden of establishing eligibility for a tax deduction. [4] Taxation — Deductions — Construction — Ambiguity — Strict Construction. When a tax deduction statute is ambiguous, it is construed strictly, though fairly and in keeping with the ordinary meaning of the statutory language, against the taxpayer. [5] Taxation — Classification — Determination. A court looks to the substance, rather than the form, of a business activity to assess a proper tax classification for the activity. [6] Statutes — Construction — Question of Law or Fact — Review — Standard of Review. Statutory interpretation is a question of law that is reviewed de novo. [7] Statutes — Construction — In General. A court's goal when interpreting a statute is to give effect to the legislature's intent. The court first looks to the plain language of the statute to determine its meaning. Disputed statutory language is reviewed in the context of the statute as a whole. The court will seek to avoid strained, unlikely, or unrealistic statutory interpretations. Absent ambiguity or a statutory definition, the words used in the statute are given their common and ordinary meaning. In determining the plain meaning of an undefined statutory term, a court may look to a dictionary to ascertain the common meaning of the term. If the statute is ambiguous, i.e., it is susceptible to more than one meaning, a court will look to other evidence of legislative intent, such as legislative history. In addition, a court accords great weight to the contemporaneous construction placed on the statute by officials charged with its enforcement, especially if the legislature has silently acquiesced in that construction over a long period of time. [8] Taxation — Business and Occupation Tax — Deductions — Interest Earned on Real Estate Loans — "Interest" and "Derived" — What Constitutes. For purposes of the business and occupation tax deduction afforded by RCW 82.04.4292 for amounts derived from interest received on secured loans used for the purchase of nontransient residential property, "interest" is a "charge for the use or forbearance of money" and "derived" means "formed or developed out of something else." The statute requires that the amount at issue be an amount "formed or developed" from a charge made for the use or forbearance of money. [9] Taxation — Business and Occupation Tax — Deductions — Interest Earned on Real Estate Loans — Interest Retained as Compensation for Servicing Loans Sold on Secondary Market. Where a lender originates a qualifying home loan and sells the loan on the secondary market under an agreement that requires the lender to service the loan, amounts retained by the lender from interest payments as compensation for servicing the loan are not deductible from business and occupation taxes as "amounts derived from interest received" under RCW 82.04.4292. Nature of Action: A residential mortgage lender sought a refund of business and occupation taxes based on a statutory deduction for amounts derived from interest received on secured loans used for the purchase of nontransient residential property. The lender sought the refund for the amount of loan interest retained by the lender as compensation for its servicing of loans originated by the lender that were sold by the lender on the secondary market under agreements that required the lender to service the loans. Superior Court: The Superior Court for Thurston County, No. 03-2-00432-1, Chris Wickham, J., on April 21, 2006, entered a summary judgment in favor of the Department of Revenue, dismissing the claim with prejudice. Court of Appeals: Holding that the lender was not entitled to the interest deduction, the court affirms the judgment. Gregg D. Barton-, Scott M. Edwards-, and Robert L. Mahon III- (of Perkins Coie, LLP), for appellants. Robert M. McKenna-, Attorney General, and Donald F. Cofer- and Mary C. Lobdell-, Assistants, for respondent. ¶1 QUINN-BRINTNALL, J. — HomeStreet, Inc., sued the Department of Revenue (DOR) for a refund of business and occupation (B&O) taxes it alleged that it had overpaid. This case of first impression requires that we address whether RCW 82.04.4292 allows a lender to deduct, as "amounts derived from interest received," service fees it earned on qualifying home loans it originated and then sold on the secondary market under agreements that required loan servicing. DISCUSSION THE STATUTORY DEDUCTION ¶2 RCW 82.04.4292 allows those engaged in "banking, loan, security or other financial businesses" to deduct "amounts derived from interest received on" certain investments or loans when computing their B&O taxes. Specifically, the statute provides: In computing tax there may be deducted from the measure of tax by those engaged in banking, loan, security or other financial businesses, amounts derived from interest received on investments or loans primarily secured by first mortgages or trust deeds on nontransient residential properties. RCW 82.04.4292 (emphasis added). THE LOANS AND SERVICING RIGHTS ¶3 HomeStreet, Inc., ¶4 HomeStreet sells or securitizes most of the loans it originates on the secondary market. An undivided interest in mortgages, specified in the applicable participation certificate that is evidence of such interest. A "participation interest" or "participation interest in mortgages" consists of a specified percentage of the principal (and a like percentage of all rights and benefits of the mortgagee or equivalent party under such mortgage) together with a specified yield on it. 2 CP at 370. Because HomeStreet's refund claim only involves loans in which it allegedly retained the servicing rights only and not an undivided interest in the mortgage, this case does not relate to any income HomeStreet may have received from participation interests. Whether RCW 82.04.4292 applies to amounts generated by retained servicing rights related to participation interests is a different question than the question presented here because HomeStreet would clearly retain some ownership interest in the loan as a whole in that case whereas, here, HomeStreet's interests appear to be entirely contractual. ¶5 In return for servicing the service retained loans, HomeStreet is entitled to retain a portion of the borrowers' interest payments, generally 0.35 to 0.40 percent of the interest portion of the payment; a set percentage of the remaining principal balance; or, in certain instances, "the difference between the interest rate on the loan and the interest rate on the security for which it serves as collateral, computed on the same principal amount and for the same period as the interest portion of the installment." 4 CP at 617. It appears that HomeStreet takes its payment from the loans' interest streams. ¶6 HomeStreet's servicing obligations and the amount of interest it may "retain" are set out in sales and servicing contracts between HomeStreet and the purchaser of the loans, usually Fannie Mae (Federal National Mortgage Association). The servicer's authorization to receive, handle, or dispose of funds representing mortgage payments (for principal, interest, and tax and insurance escrows) or of other funds or assets related to the mortgages it services for us or to the properties secured by those mortgages is limited to those servicing actions that are expressly authorized in this Guide or in the Contract. Since these funds and assets are owned by Fannie Mae and other parties (such as the borrower, a participating lender, or a mortgage-backed security holder), the servicer in its handling of these funds is acting on behalf of, and as a fiduciary for, Fannie Mae and other parties, as their respective interest may appear—and not as a debtor of Fannie Mae. If the servicer takes any action with respect to these funds or assets that is not expressly authorized—such as the withdrawal or retention of mortgage payment funds we are due as an offset against any claim the servicer may have against us the servicer is not only violating the provisions of this Guide and the Contract, but also is violating the rights of any and all other parties that have a beneficial interest in the funds. Such action is therefore prohibited and will be considered a breach of Section VIII.A.2 of the Contract. 3 CP at 514. ¶7 The contracts HomeStreet provided DOR ¶8 In most instances, HomeStreet can sell or transfer the servicing contract and retain any fee or proceeds from an approved sale or transfer, or, if the contract is terminated, it is entitled to some form of lump sum compensation. Although it does not appear that HomeStreet has ever exercised this right, the contracts also give HomeStreet the right to sell its servicing rights on the secondary market as stand-alone assets. The sales and servicing contracts, however, generally require the loan purchaser's prior approval or consent. ¶9 In addition, HomeStreet can, and occasionally does, hire third parties as sub-servicers to perform some services required under the sales and servicing contracts. Generally, HomeStreet pays the third party servicers or sub-servicers a fixed fee not related to the size of the loan or the income stream generated by the loan. ¶10 Because HomeStreet retains a portion of the interest the borrower pays based on a percentage of interest or principal rather than receiving a flat fee for servicing the loan, HomeStreet's income from the servicing right is contingent on several factors, such as the size of the loan, interest rate fluctuations, the length of the loan, whether the borrower prepays the loan, and whether the borrower defaults on the loan or the loan is foreclosed. Despite these variables, HomeStreet's servicing and administrative costs are relatively fixed. DOR AUDIT ¶11 In 1995, DOR's audit division issued written instructions to HomeStreet, informing it that RCW 82.04.4292 did not apply to the amounts HomeStreet retained from the interest payments made on servicing retained loans. Despite this notice, HomeStreet continued to follow its reading of a previous DOR contrary determination, DOR Determination No. 92-403, ¶12 Following an audit, DOR assessed B&O tax on the income HomeStreet had retained from payments it collected on servicing retained loans for the period of January 1, 1997 to December 31, 2001. DOR also required HomeStreet to start paying B&O tax on this income. REFUND ACTION AND SUMMARY JUDGMENT ¶13 HomeStreet subsequently reported and paid $20,224.72 in B&O taxes on "retained interest" received on servicing retained loans during January 2003. In March 2003, HomeStreet sued for a refund, arguing that the income generated by the "retained servicing rights" was deductible under RCW 82.04.4292 as an amount derived from interest received on qualifying loans. It brought this action under RCW 82.32.180. Relying on DOR Determination Nos. 92-392 To conclude that the amounts received are not interest would create an anomaly in the tax law which we do not think was contemplated by the legislature. Such a conclusion would mean that amounts which are plainly interest to the borrower are nonetheless not interest to those who have the right to receive it under the terms of the borrowing instrument. We conclude that the amounts in question constitute interest within the meaning of RCW 82.04.4292. 1 CP at 67-68 (footnotes omitted). But the ALJ also noted that the outcome could have been different had the taxpayer sold its entire ownership interest in the loans, and the agreements or contracts indicated that "the interest collected from the borrower was . . . bargained for consideration specifically for the rendering of collections and distribution services" rather than the servicing being "merely incidental to the distribution of the payment between the lender and investors." 1 CP at 71-72. Specifically, HomeStreet asserted that it was entitled to the deduction under DOR's new approach in DOR Determination No. 98-218, which limited the deduction to the "owner" of the loan or investment. HomeStreet argued that it was the "owner" of the loans or securities because DOR Determination No. 98-218 held that an "owner" of a loan or investment is " 'the person who retains the risk of interest rate fluctuations,' " and interest rate fluctuations affected the amount of income generated by the retained servicing rights. 1 CP at 188 (emphasis omitted). ¶14 It asserted three arguments in support of summary judgment. First, it argued that the amounts it received from the retained servicing rights were, in substance, interest because they were subject to interest rate fluctuations and other factors that affect income generated by a loan and because the servicing rights are imbedded in every residential mortgage loan. Second, it argued that according to DOR's expert, Earl Baldwin, the retained servicing assets are "derivatives that are paid from interest on the underlying mortgage loan" and that, therefore, they qualify for the deduction under RCW 82.04.4292. Br. of Appellant at 15 (emphasis added) (citing 1 CP at 50). Finally, it argued that DOR's refusal to allow the deduction undermined the legislative intent behind the deduction, which it characterized as attempting " 'to stimulate the residential housing market by making residential loans available to home buyers at lower cost through the vehicle of a B&O tax [deduction] on interest income received by home mortgage lenders.' " 1 CP at 189 (quoting Dep't of Revenue v. Sec. Pac. Bank of Wash. Nat'l Ass'n, 109 Wn. App. 795, 804, 38 P.3d 354 (2002)). HomeStreet did not, however, cite support for its conclusion that DOR's current interpretation would dampen home mortgage lending, nor did any of the documents it submitted in support of its summary judgment motion touch on this issue. ¶15 DOR opposed HomeStreet's summary judgment motion, arguing that so called "retained interest" was a fee for services rather than interest and that the fact the payments were taken from or calculated with reference to the interest collected from the loans or investments did not establish that it was income "derived from interest received." RCW 82.04.4292. DOR also asserted that HomeStreet mischaracterized Baldwin's statement regarding whether servicing income is "derived" from interest and provided a declaration from Baldwin to that effect, and that the legislative history of the deduction statute showed that the deduction was intended to apply only to "interest earned by the owner of the loan." 4 CP at 761. TRIAL COURT'S RULING ¶16 Noting that HomeStreet's financing methods did not exist 35 years ago when the legislature enacted RCW 82.04.4292, the trial court denied HomeStreet's motion for summary judgment, granted DOR summary judgment, and dismissed HomeStreet's claim with prejudice. ¶17 HomeStreet appeals the denial of its motion for summary judgment and order granting DOR summary judgment. ANALYSIS ¶18 We review an order of summary judgment de novo, engaging "in the same inquiry as the trial court, [and] treating all facts and reasonable inferences from the facts in a light most favorable to the nonmoving party." Enter. Leasing, Inc. v. City of Tacoma, 139 Wn.2d 546, 551, 988 P.2d 961 (1999) (citing Reid v. Pierce County, 136 Wn.2d 195, 201, 961 P.2d 333 (1998); Fell v. Spokane Transit Auth., 128 Wn.2d 618, 625, 911 P.2d 1319 (1996)). Summary judgment is appropriate only if the pleadings, affidavits, depositions, and admissions on file demonstrate the absence of any genuine issues of material fact, and the moving party is entitled to judgment as a matter of law. CR 56(c). "Where, as here, the parties do not dispute the material facts, [we] will affirm an order on summary judgment if the moving party is entitled to judgment as a matter of law." Enterprise Leasing, 139 Wn.2d at 551-52 (citing CR 56(c); Barnes v. McLendon, 128 Wn.2d 563, 569, 910 P.2d 469 (1996)). TAX DEDUCTION STANDARDS GENERAL RULES OF STATUTORY INTERPRETATION ¶22 Absent ambiguity or a statutory definition, we give the words in a statute their common and ordinary meaning. Garrison v. Wash. State Nursing Bd., 87 Wn.2d 195, 196, 550 P.2d 7 (1976). In determining the plain meaning of an undefined term, we may look to the dictionary to ascertain the common meaning of the term. Garrison, 87 Wn.2d at 196. ¶23 " 'Where a statute is susceptible to more than one meaning, it is ambiguous.' " Sehome Park Care Ctr., 127 Wn.2d at 778 (quoting Timberline Air Serv., Inc. v. Bell Helicopter-Textron, Inc., 125 Wn.2d 305, 312, 884 P.2d 920 (1994)). If a statute is ambiguous, we look to other evidence of legislative intent, such as legislative history. See Sehome Park Care Ctr., 127 Wn.2d at 778. In addition, we "accord great weight to the contemporaneous construction placed upon [the statute] by officials charged with its enforcement, especially where the Legislature has silently acquiesced in that construction over a long period." Sehome Park Care Ctr., 127 Wn.2d at 780. B&O TAXES AND DEDUCTION ¶24 The State imposes B&O tax on the privilege of doing business in this state. RCW 82.04.220. DOR computes B&O tax by classifying the taxpayer's activity according to various statutory definitions and applying specific tax rates to the gross income of the business. See RCW 82.04.220. Businesses engaged in the business of providing financial and banking services are generally taxable under the service and other activities classification of the B&O tax. Former RCW 82.04.290 (2001); WAC 458-20-146. ¶25 For purposes of the B&O tax, the legislature has defined gross income as: the value proceeding or accruing by reason of the transaction of the business engaged in and includes gross proceeds of sales, compensation for the rendition of services, gains realized from trading in stocks, bonds, or other evidences of indebtedness, interest, discount, rents, royalties, fees, commissions, dividends, and other emoluments however designated, all without any deduction on account of the cost of tangible property sold, the cost of materials used, labor costs, interest, discount, delivery costs, taxes, or any other expense whatsoever paid or accrued and without any deduction on account of losses. RCW 82.04.080 (emphasis added); see also WAC 458-20-146. ¶27 Factually, we note that HomeStreet's Chief Financial Officer, Debra Johnson, stated in a deposition that HomeStreet may record the income generated by the retained servicing rights contracts at issue as "servicing income" and that she was certain HomeStreet did not record this income as "retained interest." 3 CP at 540-41. This suggests that the disputed income was derived from providing services rather than interest received on investments or loans. More importantly, under the plain language of RCW 82.04.4292, ¶28 HomeStreet argues that the statutory phrase "derived from interest" includes any income taken from and related to the borrower's interest payment and that the documents before the trial court on summary judgment clearly established that the income in question was withheld from and related to the borrower's interest payments. It further asserts that Baldwin's deposition establishes that the income is " 'paid from interest' " and is " 'embedded as a part of [interest],' " and that he "testified that HomeStreet's retained interest (servicing) assets are derivatives that are paid from interest on the underlying mortgage loan." Br. of Appellant at 15 (emphasis added) (citing CP at 50). It also asserts that because this income is sensitive to many of the same factors affecting direct interest income, such as the principal balance of the loan, interest rate fluctuations, and the duration of the loan, this income is similar to interest and that the legislature intended such income to be deductible under RCW 82.04.4292. ¶29 For its part, DOR contends that the amounts in question are fees for loan services provided, regardless of whether their ultimate source is the interest portion of the borrower's payment. DOR argues that the phrase "derived from interest" "means the taxpayer must 'receive' interest" and that this portion of HomeStreet's income is not from interest but rather from fees derived solely from its contractual servicing rights. See Br. of Resp't at 13. It also asserts that, at least as to the loans it sells to Fannie Mae, HomeStreet sells "all its legal and beneficial interest in the secured loans"; that is the "servicing contract that generates its income and not the secured loans"; and that HomeStreet's only interest is contractual and this "is not secured by any lien against any real property of the borrower." Br. of Appellant at 14. ¶30 Neither the term "interest" nor the phrase "derived from" are defined by the B&O tax statutes. Because these are undefined terms, we examine the plain meaning of these terms and may look to the dictionary to ascertain the common meaning. Garrison, 87 Wn.2d at 196. ¶31 Interest is commonly defined as a "charge for the use or forbearance of money." Sec. Sav. Soc'y v. Spokane County, 111 Wash. 35, 37, 189 P. 260 (1920); see also Clifford v. State, 78 Wn.2d 4, 6, 469 P.2d 549 (1970) (citing MERRIAM-WEBSTER THIRD INTERNATIONAL DICTIONARY (1964)). "Derived" is defined as "formed or developed out of something else," WEBSTER'S THIRD INTERNATIONAL DICTIONARY 608 (1976), or "[r]eceived from specified source." BLACK'S LAW DICTIONARY 444 (6th ed. 1990). Thus, the plain language of the statute requires that the amount at issue be an amount "formed or developed" from a charge made for the use or forbearance of money. ¶32 The documents the parties submitted at summary judgment show that HomeStreet is allowed to keep or "retain" part of the interest stream generated by the loans in exchange for servicing the loans. In this respect, the income is, in the broadest sense, "derived from interest" because HomeStreet deducts it directly from the interest stream the loans generate. But HomeStreet's argument ignores the fact that the only reason it is entitled to income is its contractual relationship with the purchaser of the loan for servicing the loans and that it is merely allowed to pay itself by "retaining" part of the contract purchaser's interest payment in return. ¶33 When HomeStreet or any mortgage lender originates a mortgage loan, it creates a relationship between itself and the borrower by allowing the borrower to use its money in return for interest on its capital. This relationship falls squarely within the statutory tax deduction. But when HomeStreet sells the loan on the secondary market, it recovers the capital it invested and the borrower is no longer paying HomeStreet for using its money. And, in servicing retained sales, HomeStreet retains only the right to provide loan servicing for the purchaser of the loan and to be compensated for those services. ¶34 In fact, any servicer or sub-servicer, including those that never invested any capital in the serviced loans, could make the same argument HomeStreet relies on if the servicer or sub-servicer negotiated payment terms that required the source of payment would be the borrower's interest payment. HomeStreet's approach is thus overbroad, unreasonable, and ignores the requirement that we construe tax deduction statutes narrowly. Budget Rent-A-Car, 81 Wn.2d at 174-75; see also Simpson Inv. Co., 141 Wn.2d at 150 (if the statute is ambiguous, this court must construe the statute " 'strictly, though fairly and in keeping with the ordinary meaning of [the] language, against the taxpayer.' " (quoting Group Health, 72 Wn.2d at 429)). ¶35 We agree with the trial court that RCW 82.04.4292 allows HomeStreet to deduct interest income from qualifying home loans in computing its B&O tax but not income it earns from servicing loans it originated but then sold. We, therefore, affirm summary judgment for DOR. HOUGHTON, C.J., and VAN DEREN, J., concur.