Prentiss Willson Madison Barnett Tax Executives Institute Atlanta June 3, Combined Reporting Developments

Transcription

1 Prentiss Willson Madison Barnett Tax Executives Institute Atlanta June 3, 2014 Combined Reporting Developments

2 Agenda Move to Combined Reporting Overview MTC Model Statute Why the move? Technical Issues Composition of Group Unity Water s-edge Credits NOLs Intercompany Gains Forced Combination

3 MOVE TO COMBINED REPORTING 3

4 Combined Reporting States West of Mississippi Alaska Arizona California Hawaii Idaho Kansas Minnesota Montana Nebraska North Dakota Oregon Utah East of Mississippi Illinois Maine New Hampshire 4

5 Combined Reporting States West of Mississippi East of Mississippi Alaska DISTRICT OF COLUMBIA (2011) Arizona Illinois California Maine Hawaii MASSACHUSETTS (2009) Idaho MICHIGAN (2009) Kansas New Hampshire Minnesota NEW YORK STATE (2007; unitary eff. 2015) Montana NEW YORK CITY (2009) Nebraska VERMONT (2006) Oregon WEST VIRGINIA (2009) TEXAS (2008) WISCONSIN (2009) Utah 5

6 Combined Reporting on the Move The corporate community generally opposes MUCR The COST Board of Directors has adopted a formal policy statement on MUCR COST s policy position is: Mandatory unitary combined reporting ( MUCR ) is not a panacea for the problem of how to accurately determine multistate business income attributable to economic activity in a State. For business taxpayers, there is a significant risk that MUCR will arbitrarily attribute more income to a State than is justified by the level of a corporation s real economic activity in the State. A switch to MUCR may have significant and unintended impacts on both taxpayers and States. Further, MUCR is an unpredictable and burdensome tax system. COST opposes MUCR. 6

7 Combined Reporting on the Move: MTC Model Statute In 2006 the Multistate Tax Commission adopted a model statute for combined reporting Mandatory combined report for all taxpayers engaged in a unitary business with one or more other corporations Inclusion of all members commonly controlled engaged in unitary business Leaves it up to states to decide which factors necessary to require combination Either or both of common ownership or common control Common control usually defined by states as more than 50% rather than more than 80% 7

8 Combined Reporting on the Move: MTC Model Statute (cont d) Combined report includes income and apportionment factors of all corporations that are members of the unitary business Water s-edge election available (binding for 10 years) Tax commissioner can force combination with excluded unitary group members if necessary to reflect proper apportionment (includes persons that are not subject to the state s tax) 8

9 Combined Reporting on the Move: MTC Model Statute (cont d) Water s-edge election excludes certain non-us affiliates, except: Non-US members if average of property, payroll, and sales factor within US is 20% or more US source income of non-us members without regard to treaties Certain Subpart F income of non-us members Non-US members that earn more than 20% of income from intangible property or services related activities that are deductible by other members, to extent of income and apportionment factors Entire income of member doing business in tax haven 9

10 Combined Reporting on the Move: MTC Model Statute (cont d) State Adoption Not automatically binding on states - states have to affirmatively adopt States that have adopted variations of the MTC model: District of Columbia West Virginia Massachusetts Wisconsin 10

11 Why the Move Toward Combined Reporting? The main reasons advanced for it include: Curtailing tax planning Better measurement of in-state activity Simplification (are you kidding me?) Impact on state economy Impact of MUCR depends upon: Relative profitability of members Relative apportionment factors of members 11

12 Purported Advantages of MUCR Accelerated utilization of net operating losses Elimination of intercompany transactions Ease of administration Dilution of apportionment Decreased tax base Water s-edge election limits pool of unitary income to US Leveled playing field between small and large taxpayers 12

13 Purported Disadvantages of MUCR Neutralization of separate state tax planning Binding election may make future tax planning difficult Increased tax base Exclusion of foreign affiliates through water sedge election may cause increase in state apportionment factors Complexity and uncertainty 13

14 Overall Conclusion Arguably, these combine to provide overall advantages to taxpayers in the aggregate, especially utilization of operating losses immediately and deferral from elimination of intercompany transactions, dividends But interest of state legislatures in recent years primarily driven by belief that increased revenues will result Are the states correct? 14

15 THE TECHNICAL ISSUES 15

16 Composition of Group Tests for determining unity: Unities of ownership, operation and use Functional integration, economies of scale and centralization of management Contribution or dependency MTC regulation defines unitary business as single economic enterprise of parts sufficiently interdependent, integrated and interrelated through their activities so as to provide a synergy and mutual benefit that produces a sharing or exchange of value. 16

17 Composition of Group (cont d) What entities are included: Insurance companies? Financial institutions? REITs/RICs? Pass-through entities? Inclusion of different types of entities can raise questions with respect to meshing different apportionment methodology and/or with respect to different income or credit/loss carry forward rules 17

18 Composition of Group: State Variations New York Pre-2007 discretionary combination Between 2007 and 2014, mandatory combination if substantial intercorporate transactions exist under 10-step process Effective 2015, 10-step process replaced by more standard unitary inquiry California case law Tenneco (not unitary despite strong centralized management) Dental Insurance (dental insurance business unitary with farms) ComCon Production (Comcast not unitary with its subsidiary, QVC) 18

19 Composition of Group: State Variations Other states R.R. Donnelley & Sons (Arizona court finds PIC unitary but not accounts receivable and factoring companies) Miami Corp. (Oregon court finds various multistate entities unitary because of the existence of strong centralized management) Compare Rent-A-Center, Inc. (Oregon court finds subsidiary not unitary with parent despite being in same line of business) Envirodyne Industries (Federal court finds all entities must be unitary with each other) Recent states Massachusetts and Wisconsin similar to MTC 19

20 Instant Unity When do the operations of a newly acquired subsidiary become sufficiently integrated to become unitary with the existing business? California generally requires some (indeterminate) amount of time to elapse (i.e., the rule should be called the no instant unity rule) How much time varies with the facts and circumstances Colorado requires two tax years before becoming unitary But what if the companies were major suppliers/marketers/customers prior to acquisition? In effect, what if unitary except for lack of ownership? New York (per audit group): takes at least six months 20

21 Holding Companies Holding companies as a subset of unitary group: Are operations necessary to be combined? In Appeal of PBS Building Systems, the SBE implied that shared tax benefits, loan guaranty, covenants, and overlap of officers and directors were sufficient for unity See also FTB Legal Ruling 95-7 and 95-8 Matter of American Banknote Corp., where NYC Tax Tribunal held holding company was unitary with operating subsidiary If not combined, consider dividend and interest issues 21

22 Affiliated Group Election 22 In light of these composition of the group difficulties, should there be a movement toward affiliated group election for consolidation/combination? It should defer to federal consolidated group, be binding on taxpayer and state, and not require consent of Commissioner. Massachusetts, Wisconsin, and New York have done something similar to this, allowing the taxpayer to make a 10-year election to include all members that are in its affiliated group (using a greater than 50% ownership threshold). What conditions, if any, would be appropriate? E.g., all income apportionable? Would such a condition be constitutional? How often has the election been made?

23 Water s-edge Intercompany Inclusion The parameters of water s-edge group are hotly debated. The recent trend in states enacting CR has been to use a default water's-edge rule. Issues in the debate include: Whether foreign entity should only include US source income (and does that include effectively connected income) Whether 80/20 rule should include domestic entities Proper interpretation of MTC model rule concerning intercompany transactions with members outside the group Issues concerning MTC tax haven provision quasi-worldwide combination? Effect of US treaties that provide either that an item of income is not taxable federally or is to be subject to a reduced rate of federal tax 23

24 Joyce and Finnigan Is it the selling taxpayer? Or the group? Finnigan states include: Arizona, District of Columbia, Kansas, Maine, Massachusetts, New York (see Disney Enterprises App.), Utah California for mutual fund companies per Cal. Admin. Code, tit. 18, , and everyone beginning January 1, 2011 Texas follows Joyce but requires taxpayers to provide information that allows the state to compute the apportionment percentage that would have resulted under Finnigan Should the rule be consistent with the rule for NOLs and credits? 24

25 Credits Can they be shared? Some statutes and regulations explicitly trap credits (e.g., Hawaii, Minnesota) Some statutes permit group use (e.g., Idaho, Montana) What is the policy argument for leaving the credits trapped? Doesn t that just become a trap for the unwary? How should the credits carry forward? How are transition rules handled for credit carryforwards from prior years? Should the rules be the same for NOLs and throwbacks? 25

26 Trapped Credits Hypothetical Assume ABC manufactures its product in single sales factor state M and sells its entire output to distribution affiliate XYZ Assume ABC generates enterprise zone credits, but had no income pursuant to intrastate apportionment methodology Result: no credit 26

27 Net Operating Loss Carryforwards Lack of uniformity in state rules California intrastate apportionment rules make clear each taxpayer has its own share of the group s NOL Some states treat NOL as that of the group Massachusetts treats NOLs as those of individual entities but permits sharing in future years Transition rules can be a problem where losses only allowed to member that generated it: For example, a loss generated by a holding company may not be available where holding company intrastate apportionment percentage drops to zero, and it is not allocated a share of combined group income 27

28 Dividends Dividends from unitary subsidiary: Eliminated? Eligible for dividends received deduction? Early California Safeway case holds dividends not eliminated, but legislature overrules in RTC so long as paid from unitary earnings Tracking of E&P is administratively burdensome Should the states allow for a pure elimination of dividends paid among members, with no limitations? 28

29 Dividends (cont d) What of newly-formed subsidiary or holding company formed as part of reorganization, receiving dividend from E&P generated prior to its existence? FTB sponsored legislation effective 1 January 2009 (RTC 25106(2)) that permits dividends received deduction ( elimination ) where recipient is newly formed, if part of unitary group from date of formation. FTB can disregard if done for tax evasion purposes. What happens when the newly formed entity then dividends up to its parent? What has become of Willson s Rule? 29

30 Stock Basis in Subsidiary Is basis the same as federal consolidated rules or determined on a separate return basis? If state follows federal approach, how do you account for basis adjustments for years prior to the adoption of combined reporting? How do you account for differences created by combined group members being different from the federal consolidated group? California rules make clear the federal investment account adjustments are not taking place Could result have been changed by dividend upstream followed by contribution to capital? Should states relax any business purpose requirement for dividends up and contributions down to enable matching federal basis? 30

31 Earnings & Profits Is E&P determined on a separate return basis or on the federal consolidated return regulations concept of tiering up? Young s Market case in California held E&P determined on separate return basis 31

32 Intercompany Gains Are intercompany sales eliminated or deferred? Does it matter if the state begins with federal taxable income? After an inconsistent history, California now follows federal to the extent possible consistent with combined reporting principles. Vermont provides for similar treatment. In either case, transactions between group members as to the unitary business would apparently no longer implicate the states' add back laws. 32

33 Intercompany Gains (cont d) Assuming elimination, the correct application per unitary theory may lead to odd results: Sub manufacturers goods at a cost of $40 in state M and sells to Parent for $75 in state N; Parent then sells to third party for $100 in state O. Where/when is profit recognized? 33

34 Intercompany Gains (cont d) If state adopts federal deferral approach: May match federal unless the ownership standard is less than 80%, or the group includes foreign members. What apportionment percentage applies, year of restoration or year of deferral? Are intercompany sales eliminated from the apportionment factors? How to treat deferred items before taxpayer entered the state, i.e., were there preexisting gains? Illinois treats members as if they constituted a federal consolidated group and applies federal regulations. 34

35 Intercompany Sales Are intercompany sales eliminated from the sales factor? In Chase Brass the California court concluded that intercompany sales should be eliminated from the sales factor because no net income is created from the intercompany sale. 35

36 Nonbusiness Items Nonbusiness losses Are generally trapped at the entity generating such losses, to be added to post-apportioned income. Nonbusiness interest deduction Robert Half Int l suggests that the debt must contribute materially to the production of business income. 36

37 Nonbusiness Items Hypothetical Assume private equity fund acquisition subsidiary acquires Target Assume Target then incurs debt to pay dividend Is the interest deductible? Does the debt contribute materially to the production of business income? 37

38 Capital Gains and Losses California has an elaborate regulation calling for separating and then netting various preferred items What to do in states with no clear rules? 38

39 Partnership Issues Subject of recent FTB Interested Parties Meeting: How are distributive shares of items from non-unitary partnerships treated? What about the indirect ownership of business assets (specifically, assets that are nonbusiness in the partnership s hands but would be business in the partner s hands)? Possible expansion of rule eliminating sales between partner and partnership. 39

40 Statute of Limitations, Elections, Methods Does the group have a single, common statute of limitations? Assessments Refunds For combination itself (Turbodyne Corp. and Panavision) Does the group have a single, common set of elections? Must all be on same accounting method? Is tax liability individual or joint and several? 40

41 FORCED COMBINATION 41

42 No Statutory Rules, Only Court Decisions South Carolina Media General No statutory basis for combined reporting Parties stipulated that group was unitary, and that the standard apportionment formula resulted in distortion Department agreed combination more fairly represented the group s business activities in SC Allowed combination under statute based on UDITPA Section 18 Draft Revenue Ruling Proposed forced combination in certain fact patterns Withdrawn May 1,

43 No Statutory Rules, Only Court Decisions (cont d) North Carolina Wal-Mart Stores Taxpayer must include REIT in a combined filing Relied on constitutional analysis Upheld penalty Delhaize Allowed combination under Wal-Mart standard Upheld penalty Regulations and changes to the combined reporting statute effective Jan. 1, 2012 Regulations deem transactions in excess of cost as indicating true earnings are not reported 43

44 Cases Cited Above Tenneco West, Inc. v. Franchise Tax Bd., 234 Cal.App.3d 1510 (1991) Dental Ins. Consultants, Inc. v. Franchise Tax Bd., 1 Cal.App.4th 343 (1991) ComCon Production Services I, Inc. v. Franchise Tax Bd., Case No. BC (Los Angeles Super. Ct. Mar. 6, 2014) R.R. Donnelley & Sons Co. v. Arizona Dep t of Revenue, 229 P.3d 266 (Ariz. Ct. App. 2010) Miami Corp. v. Dep't of Revenue, No. TC-MD C (Or. T.C. Feb. 17, 2005) Rent-A-Ctr., Inc. v. Dep't of Revenue, TC-MD D (Or. T.C. May 12, 2014) Envirodyne Industries, 354 F.3d 646 (2004) 44

45 Cases Cited Above (cont d) Appeals of PBS Bldg. Sys., Inc., and PKH Bldg. Sys., Inc., No. 94-SBE-008 (Cal. State Bd. of Equalization Nov. 17, 1994) Matter of American Banknote Corp., TAT (E) (GC); TAT (E) (GC); TAT (E) (GC) (N.Y.C. Tax App. Trib., Nov. 2008) Robert Half Int l Inc. v. Franchise Tax Bd., 66 Cal.App.4th 1020 (1998) Appeal of Joyce, No. 66-SBE-070 (Cal. State Bd. Of Equalization, November 23, 1966) Appeal of Finnigan Corporation, No. 88-SBE-022, (Cal. State Bd. Of Equalization, August 25, 1988) Matter of Disney Enters., Inc., 888 N.E.2d 1029 (N.Y. 2008) Bausch & Lomb, Inc., DTA No (N.Y.S. Tax App. Trib., Dec. 20, 2007) Chase Brass v. Franchise Tax Board, 70 Cal.App.3d 457(1977) 45

46 Cases Cited Above (cont d) Safeway Stores v. Franchise Tax Board, 3 Cal.3d 745 (1970) Young s Market Company, No. 86-SBE-198, (Cal. State Bd. Of Equalization, November 19, 1986) Media Gen. Commc ns, Inc. v. South Carolina Dep t of Revenue, 694 S.E.2d 525 (S.C. 2010) Wal-Mart Stores East, Inc. v. Hinton, 676 S.E.2d 634 (N.C. Ct. App.), app. dismissed, 689 S.E.2d 375 (N.C. 2009) Delhaize Am. Inc. v. Lay, 731 S.E.2d 486 (N.C. Ct. App. 2012) Turbodyne Corp. v. Tax Appeals Tribunal, 245 A.D.2d 976 (N.Y. App. Div. 3d Dep t 1997) Panavision, Inc., DTA No (N.Y.S. Tax App. Trib., June 6, 2002) 46

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