Mandatory Combined Reporting for State Income Taxes

Presenting a live 110‐minute teleconference with interactive Q&A

Mandatory Combined Reporting for State Income Taxesfor State Income TaxesImproving Tax Compliance to Manage Conflicting State Rules

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

THURSDAY, JUNE 14, 2012

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Brian Browdy, Director, Tax Strategy, Ryan, Chicagoy, , gy, y , g

Marianne Evans, Senior Manager, KPMG, Washington, D.C.

Dan Lapour, State and Local Tax Manager, Moss Adams, Portland, Ore.

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M d t C bi d R ti f Mandatory Combined Reporting for State Income Taxes Seminar

June 14, 2012

Dan Lapour, Moss [email protected]

Brian Browdy, [email protected]

Marianne Evans, KPMG

[email protected]

Today’s Program

Mandatory Vs. Elective Combined Reporting Background[Brian Browdy]

Slide 7 – Slide 33

Recent State Developments With Combined Reporting[Dan Lapour and Marianne Evans]


Recent Developments With Forced Combinations And Including Non-Corporate Entities In Combined Return[Marianne Evans]


Future Outlook On Combined Reporting Trend[Brian Browdy, Dan Lapour and Marianne Evans]


MANDATORY VS ELECTIVE Brian Browdy, Ryan

MANDATORY VS. ELECTIVE COMBINED REPORTING BACKGROUND

Spreading The Wealth: What IsSpreading The Wealth: What Is“Combined” Or “Unitary” Reporting?“Combined” Or “Unitary” Reporting?y p gy p g

It is not:Separate accounting– Separate accounting Use of internal accounting records to isolate individual items of

revenue and expense of a multi-state enterprise on a geographic or functional basis, Exxon Corp. v. Wisconsin g g p , pDep’t of Revenue, 447 U.S. 207 (1980) (separate accounting not constitutionally mandated)

– Specific allocation Assignment of certain items of income (e.g., interest, capital

gains, rents from real property) to a single jurisdiction based on statutory rules

S t fili– Separate filing Each company doing business in a state figures its income or

loss, files its return, and pays its taxes separately from its parent or any of its corporate (or non-corporate) affiliates

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parent or any of its corporate (or non corporate) affiliates.

Continued … So, What Is It?Continued … So, What Is It?

An alternative method for determining the portion of the net profits (or loss) of a multi-state group of companies that is attributable to, and then taxed in, a given jurisdictionEffectively treats commonly owned companies engaged in a “unitary business” as a single, organic economic enterprise for most state income tax purposes– In most combined reporting states, composition of unitary business

group is not the same as the federal consolidated group. – Membership in a taxpayer’s unitary group is determined without

regard to whether unitary affiliates are doing business in the taxing state.

– Composition of a unitary group may differ from state to state.The nationwide (and in some cases, worldwide) profits of the unitary business group are combined, and the state then taxes the share of

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g p ,the combined income attributable to any in-state activities conducted by unitary group members.

Continued ... Why Do States Require It?Continued ... Why Do States Require It?

Historical explanation is that:– Separate filing and separate accounting:

Fail to reflect “contributions to production of income by activities Fail to reflect contributions to production of income by activities conducted in other states” Butler Bros. v. McColgan, 315 U.S. 501 (1942)

Do not adequately capture “subtle and largely unquantifiable transfers of value that take place among the components of a single enterprise”of value that take place among the components of a single enterprise Mobil Oil Corp. v. Comm’r of Taxes of Vermont, 445 U.S. 425, 438-39 (1980)

Modern justification is that:– Other methods are defenseless against planning techniques used by

“members of the tax-avoidance community” “Designing a Combined Reporting Regime for a State Corporate Income Tax,” 61 Louisiana Law Rev. 699, 700 (Summer 2001), McIntyre, Mines and Pomp, ( ), y , p IP holding companies Contract manufacturers, embedded royalty company Transfer pricing, IRC Sect. 482 planning

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Captive REITs, RICs Captive insurance subsidiaries Overseas management affiliates

In An Nutshell …In An Nutshell …

Translation: Can’t unscramble the omelet

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Step One: Defining The “UnitaryStep One: Defining The “UnitaryBusiness” ScopeBusiness” Scopepp

A combined report is required from “any taxpayer engaged in a unitary business, a part of which is conducted in the taxing state.”The first step in the process is determining the composition of the taxpayer’s

it b iunitary business group.Mandates qualitative and quantitative examination of interactions and inter-dependencies among corporations linked by common ownership– May also require analysis of economic and other relationships between

divisions of a single companydivisions of a single companyMany tests, few bright lines– Three unities (California)

Unity of ownership: Direct or indirect control over 50% of voting stock U it f ti C t li d h i d ti i ti d Unity of operations: Centralized purchasing, advertising, accounting and

management Unity of use: Centralized executive force and general system of

operation. Contribution and dependency– Contribution and dependency Activities within taxing state contribute to, or depend upon, the operation

of the business without the state – Factors of profitability

Functional integration

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Functional integration Centralized management Economies of scale

– Multistate Tax Commission

You Know It When You See It:You Know It When You See It:Hallmarks Of A “Unitary Business”Hallmarks Of A “Unitary Business”yy

Inter-company sales or transactions not at arm’s length

Dividend policyLoan guaranteestransactions not at arm s length

Similarity or diversity of businessesResearch and development

Loan guaranteesPurchasingShared services

LegalpManagement activitiesInterlocking boards, overlapping officers

– Legal– Regulatory – Tax

E l b fitTransfer or sharing personnel, expertiseInter-company financing, use of

– Employee benefits– Human resources– Computer, servers

Iinter-company accountBudget creation, approvalCapital acquisitions, divestitures ( di li it l )

InsuranceMarketing

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(spending limits, approvals)

PrePre--2006 Combined (Unitary) States2006 Combined (Unitary) States

Alaska (worldwide combined reporting*)

MississippiM treporting )

ArizonaCalifornia (elective WWCR)

MontanaNebraskaNew Hampshire

ColoradoHawaiiIdaho (elective WWCR)

North Dakota (elective WWCR)Ohio (if not “consolidated elected”)( )

IllinoisKansasMaine

)Utah (elective WWCR)Vermont

MaineMinnesota

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* Mandatory for oil companies

The Wave Of The Future?The Wave Of The Future?

Five years ago, less than 30% of the U.S. economy, represented by 16 states used combined reporting16 states used combined reporting

Today, more than 55% of domestic economic activity takes place in states mandating combined reporting for unitary businesses.g p g y

Prior to Vermont’s adoption of combined reporting beginning in 2006, no state had adopted the method for two decades.p

Since 2007 alone, eight states have adopted mandatory combined apportionment for unitary businesses.

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New To The GameNew To The Game

New mandatory combined reporting states (year adopted)C ti t (2009)– Connecticut (2009)

– District of Columbia (2011)– Massachusetts (2008)– Michigan (2007)– New York (2007)– Texas (2006)Texas (2006)– West Virginia (2007)– Wisconsin (2009)

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Visions Of New Revenues?Visions Of New Revenues?

COST study (May 2008) highlightsC bi d ti h t i ff t t t– Combined reporting has uncertain effects on state revenues.

– Each state’s revenue experience is unique.– Associated compliance, administrative and litigation costs are

significant.– Mandatory combined reporting significantly affects a state’s

economic growth and competitiveness.– Mandatory combined reporting achieves much the same revenue

effect as add-back statutes do.

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Related Issues: State Alternatives ToRelated Issues: State Alternatives ToCombined ReportingCombined Reportingp gp g

Economic nexus – Geoffrey: The long neck of nexus

Addback statutes

Factor presence nexus

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Related Issues: Economic NexusRelated Issues: Economic Nexus

Economic nexus: Background– The law of “substantial nexus”

Under the U.S. Supreme Court’s Commerce Clause jurisprudence, no state tax is valid unless “applied to an activity having a ‘substantial nexus’” with the taxing state. Complete Auto Transit Inc Brad 430 U S 274 (1977)Transit, Inc. v. Brady, 430 U.S. 274 (1977)

Quill and the physical presence standard In Quill Corp. v. North Dakota, 504 U.S. 298 (1992), the U.S.

S C t l d th t d th C ClSupreme Court ruled that under the Commerce Clause, North Dakota could not compel an Illinois-based retailer to collect tax on purchases made by North Dakota, because the retailer lacked a “substantial nexus” with the state.retailer lacked a substantial nexus with the state.» In so doing, the court defined “substantial nexus” in terms

of a seller’s physical presence, holding that a state may not require a seller to collect tax from its residents if the

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qseller’s only contact with customers in the state is via U.S. mail or common carrier.

Related Issues: Economic Nexus (Cont.)Related Issues: Economic Nexus (Cont.)

Geoffrey, Inc. – Quill: Law of the land, but only in the land of North DakotaDakota – In Geoffrey, Inc. v. South Carolina Tax Comm’n, 437 S.E.2d 13

(S.C. 1993), the Supreme Court of South Carolina established a constitutional firewall against the Quill physical presence standardconstitutional firewall against the Quill physical presence standard.

– At issue was whether Geoffrey, a Delaware holding company, could be subjected to the state’s income tax and business licensee fee when its presence there was limited to ownership offee, when its presence there was limited to ownership of trademarks and trade names used in the state by its retail affiliate, Toys R Us.The court declared: “It is well settled that the taxpayer need not– The court declared: It is well settled that the taxpayer need not have a tangible, physical presence in a state for income to be taxable there. The presence of intangible property alone is sufficient to establish nexus.”

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sufficient to establish nexus.


Son of Geoffrey– Arizona: Case No. 200700083-C (Mar. 27, 2008)– Indiana: MBNA America Bank v. Ind. Dep’t of Revenue, 895

N.E.2d 140 (Ind. Tax Ct. 2008)– Iowa: KFC Corp. v. Iowa Dep’t of Revenue, 792 N.W.2d 308 (Iowa

Sup. Ct. 2010)– Louisiana: Bridges v. Geoffrey, Inc., 984 So.2d 115 (La. App. 1 Cir.

2008)– Maryland: Comptroller of the Treasury v. SYL, Inc., 825 A.2d 399

(Md. Ct. of Appeals 2003)– Massachusetts: Geoffrey, Inc. v. Comm’r of Revenue, 899 N.E.2d y

87 (Mass. Sup. Ct. 2009)– New Mexico: Kmart Props., Inc. v. N.M Taxation and Rev. Dep’t,

131 P.3d 27 (Ct. App. 2001)

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( pp )– New Jersey: Lanco, Inc. v. Dir. Div. of Taxation, 879 A.2d 1234

(N.J. App. Div. 2005)


Son of Geoffrey (Cont.)N th C li A&F T d k I T l 605 S E 2d 187– North Carolina: A&F Trademark, Inc. v. Tolson, 605 S.E.2d 187 (N.C. Ct. App. 2004)

– Oklahoma: Geoffrey, Inc. v. Okla. Tax Comm’n, 132 P.2d 132 (Okl Ct A 2006)(Okla. Ct. App. 2006)

– Washington: General Motors v. City of Seattle, 25 P.3d 1022 (Wash. Ct. of App. 2001)

– West Virginia: Tax Comm’r v. MBNA America Bank, 640 S.E.2d 226 (W. Va. Sup. Ct. 2006)

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Related Issues: Addback StatutesRelated Issues: Addback Statutes

MTC model statute requiring the addback of certain related-party expenses (2004)expenses (2004)– General framework

In most states, the “taxable income” computation begins with f d l t bl i b t th i i dditi dfederal taxable income, but then requires various additions and subtractions that differ state by state.

The majority of separate-company jurisdictions now adopt f f l t d t ddb k i tsome form of related-party expense addback requirement.

In general, these statutes require the addback of interest and intangible expenses.

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Related Issues: Addback Statutes (Cont.)Related Issues: Addback Statutes (Cont.)

Interest expense: Amounts directly or indirectly allowed as deductions under

I l R C d (IRC) S 163Internal Revenue Code (IRC) Sect. 163

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Intangible expense:E l d t f l t d t i ti di tl– Expenses, losses and costs for, related to, or in connection directly or indirectly with the direct or indirect acquisition, use, maintenance or management, ownership, sale, exchange, or any other disposition of intangible property to the extent such amountsother disposition of intangible property to the extent such amounts are allowed as deductions or costs in determining taxable income before operating loss deductions and special deductions for the taxable year under the IRCtaxable year under the IRC

– Amounts directly or indirectly allowed as deductions under Sect. 163 of the IRC for purposes of determining taxable income under the IRC to the extent such expenses and costs are directly orthe IRC to the extent such expenses and costs are directly or indirectly for, related to, or in connection with the foregoing expenses, losses and costs

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Intangible expenses (Cont.):L l t d t i d i ti di tl i di tl– Losses related to, or incurred in connection directly or indirectly with, factoring transactions or discounting transactions

– Royalty, patent, technical and copyright fees– Licensing fees– Other similar expenses and costs

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Exceptions: Unless an exception applies, the deductions are disallowed Common exceptions include:disallowed. Common exceptions include:– The percentage exception

Permits deduction to the extent that the taxpayer establishes th t ( th thi ) th i t d t t l tthat (among other things), the payee is taxed at a rate equal to or greater than a rate [XX] percentage points less than the rate of tax applied to the taxpayer in the taxing state

Th “ bl ” ti– The “unreasonable” exception Permits deduction if the taxpayer shows by clear and

convincing evidence that its disallowance would be blunreasonable

– The “business purpose” exception Permits deduction if the transaction giving rise to the expense

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was undertaken for a valid business purpose


These statutes are like snowflakes ... study them carefully.Al b Al C d 40 18 35(b) Al d i 810 3 35 02– Alabama: Ala. Code 40-18-35(b); Ala. admin. reg. 810-3-35-.02 (VFJ Ventures, Inc. v. Surtees, 8 So.3d 983 (Ala. Sup. Ct. 2008))

– Arkansas: Ark. Code Ann. 26-51-423(g)– Connecticut: Conn. Gen. Stat. 12-218; Special Notice 2003(22)– District of Columbia: D.C. Code Ann. 47-1803.03(d)(7)– Georgia: Ga. Code Ann. 48-7-28.3(b); Ga. Comp. R. & Regs. 560-g ( ) p g

7-3-.05– Illinois: 35 ILCS 5/203(b)(E-13); 86 Ill. Admin. Code 100.2430

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Snowflakes ... study them carefully (Cont.)I di I d C d 6 3 1 3 5(b)(9) 6 3 2 20– Indiana: Ind. Code 6-3-1-3.5(b)(9), 6-3-2-20

– Kentucky: Ky. Stat. Ann. 141.205– Maryland: Md. Code Ann. 10-306.1– Massachusetts: Mass. Gen Laws. Chap. 63, Sect. 31I, J – Michigan: Mich. Comp. Laws 206.623(2)(e), 208.1201(2)(f)– Mississippi: Miss. Code Ann. 27-7-17(2)Mississippi: Miss. Code Ann. 27 7 17(2)– New Jersey: N.J. Stat. Ann. 54-10A-4 (Beneficial New Jersey, Inc.

v. Director, Div. of Taxation, No. 009886-2007, NJ Tax Court, Aug. 31, 2010)31, 2010)

– New York: N.Y. Tax Law 208(9)o

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Snowflakes ... study them carefully (Cont.)N th C li N C St t G 105 130 7A– North Carolina: N.C. Stat. Gen. 105-130.7A

– Ohio: Ohio Rev. Code Ann. 5733.042– Oregon: Or. Admin. R. 150-314.295– Rhode Island: R.I. Gen. Laws 44-11-11(f)– South Carolina: S.C. Code Ann. 12-6-1130– Tennessee: Tenn. Code Ann. 67-4-2006(d); Important Notice No.Tennessee: Tenn. Code Ann. 67 4 2006(d); Important Notice No.

04-32; 2012 Tenn. Pub. Law 842, sections 1-5– Virginia: Va. Code Ann. 58.1-402(B)

West Virginia: W Va Code St R 11-24-4b– West Virginia: W. Va. Code St. R. 11-24-4b– Wisconsin: Wis. Stat. 71.26(2)(a), 71.80(23)

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Related Issues: Factor PresenceRelated Issues: Factor Presence

Factor presence, “bright-line” nexusMTC U if it P l (2002)– MTC Uniformity Proposal (2002) For purposes of state business activity taxes, a person has a

substantial nexus with a taxing jurisdiction if in that state, any f th f ll i th h ld i d d”of the following thresholds is exceeded”: $50,000 of property $50,000 of payroll $500,000 of sales 25% of total property, payroll or sales

– Prior to 2010, only three states adopted a factor presence nexusPrior to 2010, only three states adopted a factor presence nexus standard: Ohio (2005), Michigan (2008), and California (2009).

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Related Issues: Factor Presence (Cont.)Related Issues: Factor Presence (Cont.)

Factor presence, “bright-line” nexus (Cont.) – The trendsetters:

Ohio: Nexus standard for commercial activity tax based on MTC model statute (Ohio. Rev. Code 5751.01H))

California: Nexus standard for franchise tax based on MTC California: Nexus standard for franchise tax based on MTC model statute (Cal. Rev. & Tax Code 23101)

Michigan: A person has a substantial nexus with the state if (i) it has a physical presence for more than one day during theit has a physical presence for more than one day during the tax year, or (ii) it actively solicits in the state and has gross receipts of at least $350,000 sourced to Michigan (Mich. Comp. Laws. 208.1200(1)).p ( ))

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Related Issues: Factor Presence (Cont.)Related Issues: Factor Presence (Cont.)

Factor presence, “bright-line” nexus (Cont.)– Recent developments– Recent developments

Colorado: Adopted by regulation, nexus standard based on MTC model statute (1 Colo. Code Regs. 39-22-301.1)

Connecticut: A person has nexus with the state if the Connecticut: A person has nexus with the state if the frequency, quantity and systematic nature of its economic contacts result in at least $500,000 attributable to Connecticut sources (Conn Gen Stat 12-216a; Info Publication Sep 23sources. (Conn. Gen. Stat. 12-216a; Info. Publication, Sep. 23, 2010)

Oklahoma: Nexus standard for business activity tax based on MTC model statute (68 Okla Stat 1218(H))MTC model statute (68 Okla. Stat. 1218(H))

Washington: Nexus standard for business and occupation tax based on MTC model statute, except sales threshold lowered to $250 000 (Wash Rev Code 82 04 067)

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to $250,000 (Wash. Rev. Code 82.04.067)– Miscellaneous: In Virginia, nexus if any apportionment factor

(payroll, property or sales) is positive (23 VAC 10-120-90(A))

D L M Ad

RECENT STATE

Dan Lapour, Moss AdamsMarianne Evans, KPMG

RECENT STATE DEVELOPMENTS WITH COMBINED REPORTING

Thematerialappearinginthispresentationisforinformationalpurposespp g p p ponlyandisnotlegaloraccountingadvice.Communicationofthisinformationisnotintendedtocreate,andreceiptdoesnotconstitute,alegal relationship including but not limited to an accountant clientlegalrelationship,including,butnotlimitedto,anaccountant‐clientrelationship.Althoughthesematerialsmayhavebeenpreparedbyprofessionals,theyshouldnotbeusedasasubstituteforprofessionalservices.Iflegal,accounting,orotherprofessionaladviceisrequired,theservicesofaprofessionalshouldbesought.

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N iNotice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation the tax treatment or tax structure or both of any transaction without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

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District Of ColumbiaDistrictOfColumbia

• Mandatorycombinedreporting

• EffectivefortaxyearsbeginningonorafterJan.1,2011,combinedy g g JreportingisrequiredintheDistrictforcorporationsengagedinaunitarybusiness.

• A“commonlycontrolledgroup”existswherethereiscommonownershipofstockrepresentingmorethan50%ofthevotingpowerofthecorporationsinthegroup.p p g p

• Acombinedgroupwillfileonawater’sedgebasis(U.S.companiesonly) but can make a 10‐year election for worldwide combination.

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only)butcanmakea10 yearelectionforworldwidecombination.

District Of Columbia (Cont )DistrictOfColumbia(Cont.)

• Corporationstobeincludedinacombinedgroup• Regulationsspecifythatthecorporationstobeincludedinacombinedgroupinclude,butarenotlimitedto,any:

o Financialinstitutiono Utilitycompanyo Transportationcompany

I i l d d f bi d

o Scorporationo Realestateinvestmenttrust(REIT)o Regulatedinvestmentcompany(RIC)

• Insurancecompaniesareexcludedfromacombinedgroup.

• Determinationoftaxableincomeorloss• Eachtaxablememberisresponsiblefortax,basedonitstaxableincomeorlossapportionedorallocatedtotheDistrict.Businessincomeofthegroupisasummationoftheindividualnetbusiness

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incomesofallmembersofthecombinedgroup.


• Netoperatinglossesandcredits

• Pre‐combinationnetoperatinglossesgeneratedbydiscretep g g ymembersoftheunitarygroupcannotbeusedtooffsetcombinedincome.

• Anetoperatinglossderivedfromactivitiesaspartofacombinedgroupisanattributeoftheseparatecorporationthatgeneratedit.AtaxablemembermaynotsharetheNOLcarryforwardwithothery ymembersofitscombinedgroup.

• A tax credit also is a separate attribute of the taxable member that

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Ataxcreditalsoisaseparateattributeofthetaxablememberthatgeneratedit.


• UnincorporatedBusinessEntities• Ifanymemberofthecombinedgroupownsanunincorporatedbusinesssubjecttounincorporatedbusinessfranchisetax,themember’sshareofthatincomethatwasactuallytaxedattheunincorporatedbusinesslevelshallbesubtractedfromthemember’sincome.

• TransitionalIssues• Requirementsforclosingoutseparateentityaccountsq g p y• Treatmentofestimatedtaxpaymentsthatweremadeonaseparatecompanybasis

• Procedures regarding extensions to file

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Proceduresregardingextensionstofile

Other Recent DevelopmentsOtherRecentDevelopments

• RhodeIsland• Generally,RhodeIslandrequirestaxpayerstofileonaseparate

companybasis.• Recentlegislationrequiresanycorporationthatispartofaunitary

businesstofileacombinedgroupinformationalreturn.• Awater’sedgefilinggroupismandatory.g g g p y• Thecombinedreportwillexcludepass‐throughentities,disregarded

entities,publicservicecorporations,stateornationalbanks,insurancecompaniesandcorporationsthatarenotsubjecttop p jtaxationundertheInternalRevenueCode.

• Anetoperatinglosscreatedbeforethe2011taxableyearwillonlybeallowedtooffsettheincomeofthecorporationthatcreatedthe

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pNOL,andcannotbesharedwithothermembersofthecombinedgroup.

OtherRecentDevelopments(Cont.)

• Rhode Island (Cont )• RhodeIsland(Cont.)• Theproformacombinedreportmustbefiledasaninformational

ScheduleCRSattachedtotheRhodeIslandbusinesscorporationtaxreturn for the 2011 and 2012 taxable yearsreturnforthe2011and2012taxableyears.

• Thecombinedreportautomaticallyqualifiesforasix‐monthextensionfromtheduedate,providedthattherelatedcorporatetaxreturn is on extension and complies with instructions outlined inreturnisonextensionandcomplieswithinstructionsoutlinedinFormRI‐7004.

• TheTaxationDivisionwillmakeavailableanewformonwhichtaxpayers may file for an additional one month extensiontaxpayersmayfileforanadditionalone‐monthextension.

• Anycorporationthatisrequiredtofileacombinedreportandwhichfailstofileatimelyreportshallbeassessedapenaltynottoexceed$10 000 Each member of the combined group will be assessed a

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$10,000.Eachmemberofthecombinedgroupwillbeassessedaseparatepenalty,andeachmemberofthegroupshallbejointlyandseverallyliableforthepenalty.

I di T C D i iIndiana Tax Court DecisionsRent-A-Center East, Inc. v. Dep’t of State Revenue (Ind. Tax Ct. May 27, , p f ( y ,

2011)

I. Department did not present prima facie evidence that it had considered other means to fairly reflect taxpayer’s Indiana adjusted considered other means to fairly reflect taxpayer s Indiana adjusted gross income, prior to forcing combination.

A. Under Indiana law, a forced combination is last resort to cure distortion created by separate filing Department must use its distortion created by separate filing. Department must use its other discretionary powers first to fairly reflect taxpayer’s AGI

AE Outfitters Retail Co. v. Dep’t of State Revenue (0ct. 25, 2011)

I. Based on the plain and unambiguous language of the statute, the Indiana Tax Court held that the Department must ascertain whether each of the alternatives to combined reporting would fairly reflect the taxpayer’s income, before it can require a combined return.

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I di S C D i iIndiana Supreme Court DecisionI. Dep’t of State Revenue v. Rent-A-Center East, Inc. (Ind. Mar. 9, 2012)p f , ( , )

A. Indiana Supreme Court reversed Tax Court conclusion that the DoR must present prima facie evidence that it had considered other means to fairly reflect a taxpayer’s Indiana adjusted gross y p y j gincome, before it could force combination.

1. Significantly, the court observed that a notice of proposed assessment is prima facie evidence that the DoR’s claim for assessment is prima facie evidence that the DoR s claim for an unpaid tax was valid.

B. After the DoR issues its prima facie assessment, the burden shifts to the taxpayer to present evidence demonstrating a shifts to the taxpayer to present evidence demonstrating a genuine issue of material fact with respect to the unpaid tax.

1. Such evidence could include that another method available to the DoR o ld ha e been s fficient to acc ratel reflect to the DoR would have been sufficient to accurately reflect Indiana adjusted gross income tax.

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T P li L R liTexas Policy Letter RulingLetter No 201108165L (Aug 9 2011)Letter No. 201108165L (Aug. 9, 2011)

I. If the comptroller determines that certain taxable entities should have filed as a combined group, then the resulting group can elect to use any method (deducting COGS or compensation or paying 70% of use any method (deducting COGS or compensation, or paying 70% of margin) that was previously elected by any group member.

A. The method is not restricted to the method used by the entity h th ti tit f th bi d chosen as the reporting entity for the combined group.

II. However, if the new group includes a member that did not previously file a franchise tax report, then the combined group is limited to the methods previously used by filing group members.

A. A non-filer may not file a separate report and make a separate election.

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ll dIllinois HB 2955, Signed Aug. 23, 2011

I. Factors and income of a holding company that is part of more than one unitary business group (because of differing apportionment methodologies) are included in each unitary business group, on a pro rata basis.

II. Taxpayers may use gross receipts or some other reasonable method to allocate the holding company’s income and factors.

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• NewYork• TheNewYorkTaxAppealsTribunalruledthataforeigncorporation

wasrequiredtofileonacombinedbasiswithonesubsidiary,butnotanother.IntheMatterofKellwoodCo.,NewYorkDivisionofTaxAppeals,TaxAppealsTribunal,DTANo.820915,Sept.22,2011

• Thecasewasunderpre‐2007law,andfocusedonwhetherreportingonaseparatebasisdistortedincomeinNewYork.Thetestsanalyzedtodeterminedistortionwere:o Doctrinesofeconomicsubstanceandbusinesspurposeo Whetherthetransactionsweremadeatarm’slength

• BecauseofchangesinNewYorklaw,theTribunal’sdecisionwillnotapplytotaxyearsbeginningafter2006.However,therulingsheds

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pp y y g g glightonthestate’sapplicationoftheeconomicsubstanceandbusinesspurposetestsinothercontexts.

d hW. Va. SB 386, Signed March 30, 2012

• A foreign corporation may be included in the water's edge group, if 20% or more of its income is derived from certain intangible or service-related activities.

• New legislation clarifies that if such a foreign corporation is included in the water’s edge group, income that is exempt from federal income tax pursuant to a qualified treaty (and the factors related thereto) will not be included in determining the combined group’s West Virginia taxable income.

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• Montana• TheMontanaDepartmentofRevenuehasadoptedandamendednumerouscorporateincometaxrulesrelatedtowater’sedgeelections,effectiveSept.23,2011,including:

o Anewruledesignedtosimplifythenetoperatingloss(NOL)calculationformulti‐nationaltaxpayers,fortaxperiodsinwhichthereisachangeinfilingmethods(ARM42.23.805)

o Anewrulespecifyingtheimpactofreorganizationsonwater’sedgeelections(ARM42.26.313)

o TheadoptionoflanguagespecifyingtheNOLcalculationtobeusedbyaunitarygroup(ARM42.23.414)

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Marianne Evans, KPMG

RECENT DEVELOPMENTS WITH FORCED COMBINATIONS AND COMBINATIONS AND INCLUDING NON‐CORPORATE ENTITIES IN COMBINED ENTITIES IN COMBINED RETURN

North Carolina’s ForcedCombination Drama

Wal-Mart Stores East, Inc. v. Hinton (N.C. App. 5/19/09), ( pp )

A. Secretary of Revenue forcibly combined taxpayer, holding company and REIT

B 25% d t t t lt li d dl f h th B. 25% understatement penalty applied regardless of whether taxpayer was negligent.

Delhaize Am., Inc. v. Lay (N.C. Bus. Ct. Jan. 12, 2011)

A. Upheld state’s authority to forcibly combine the income of a parent holding company and one of its subsidiaries, in order to reflect “true net earnings” in North Carolina.

B. However, imposing 25 % penalty violated procedural due process, because taxpayer could not lawfully file combined return

C Imposition of the penalty also violated North Carolina C. Imposition of the penalty also violated North Carolina constitutional requirement that power of taxation be exercised in a “just and equitable” manner.

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N h C li L i l iNorth Carolina Legislation

HB 619 (signed June 30, 2011)

I. Limits the circumstances under which the Secretary can forcibly combine related corporations and impose penalties as forcibly combine related corporations and impose penalties as a result of additional tax owed under a combined filing

— Provisions of the bill identifying the circumstances under which a combined report can be required, and the determinations that must be made prior to imposing such a requirement, are effective only for assessments proposed for tax years beginning on or after Jan. 1, 2012.

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N h C li Di iNorth Carolina DirectiveN.C. Directive CD-11-01 (Nov. 16, 2011)( , )

• Reiterates that Department will forcibly combine taxpayers if they meet a common ownership test, are unitary, and Department believes that separate filing does not properly disclose net income.believes that separate filing does not properly disclose net income.

• For tax years beginning on or after Jan. 1, 2012, to require combination, Secretary must establish that, as filed, the taxpayer’s return does not accurately reflect North Carolina net income because return does not accurately reflect North Carolina net income because taxpayer (1) engaged in transactions that lacked economic substance or (2) were not at fair market value.

M t l h fili g t b d b ddi g b k — Must also show proper filing cannot be done by adding back, eliminating or otherwise adjusting inter-company transactions

• The Directive and statute are silent as to when addback, elimination or another adjustment will be considered insufficient to accurately reflect North Carolina income.

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d h l lPending North Carolina Legislation

I. SB 824 would require the Secretary to promulgate a rule (as opposed to a directive) addressing its authority to adjust net income or require a combined return for tax years beginning on or after Jan. 1, 2012.

A. The bill also provides an expedited process for the adoption of such a ruleadoption of such a rule.

II. The bill was passed by the Senate on May 31 and has been II. The bill was passed by the Senate on May 31 and has been referred to the Committee on Finance in the House.

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N Y k F d D bi iNew York: Forced DecombinationI. In New York, a combined return is required by law if there are , q y

substantial inter-corporate transactions (SIT) between affiliated corporations.

A. Determining if SIT exists largely mechanical/numerical exerciseA. Determining if SIT exists largely mechanical/numerical exercise

B. SIT exists if 50% or more of a corporation’s receipts or expenditures for year from one or more related corporations

C. If between 45% and 55%, receipts or expenditures during tax year and prior two years are considered

II. Some New York auditors reportedly have been seeking to decombine certain taxpayers that filed combined returns.

III. If Department does not believe SIT exists, it may assert combination is not allowed or transfer pricing adjustment, rather than p g j ,combination, is preferred means of curing any distortion

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P hi IPartnership Issues

I. Some states require partnership income to be included in a unitary combined report, if the partnership is part of the partner’s unitary business.

A. Partner’s pro rata share of income and expenses, as well as pro rata share of apportionment factors, are included in combined report e g in CA IL IN MA MN MT NEcombined report, e.g. in CA, IL, IN, MA, MN, MT, NE.

1. Sales between a unitary pass-through entity and its corporate owner generally are eliminated in computing the sales factor.

B. If not unitary, separate accounting may be appropriate

C S i l l l f f i hi C. Special rules may apply for foreign partnerships.

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N U i P hi INon‐Unitary Partnership InterestReynolds Metals Company v. Dep’t of Treasury

I. The Michigan Appeals Court held that a taxpayer was not unitary with a foreign joint venture.

A. Through a wholly owned subsidiary, a manufacturer entered into a g y y,joint venture in Australia with three other aluminum companies.

B. Joint venture’s day-to-day operations were handled through an independent management company.p g p y

II. Court found there was:

A. No functional integration (no sharing of managerial or operational resources)resources)

B. No economies of scale (no commonalities of operation that would lead to economies of scale)

C. No centralized management (taxpayer did not control a majority of seats on the executive committee)

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N Mi hi T R iNew Michigan Tax Regime

I. New corporate income tax effective Jan. 1, 2012

II. If the pass-through entity is unitary with the corporate owner, the income and factors of the pass-through entity flow up and the income and factors of the pass through entity flow up and are added to the corporate partner’s income and factors.

A. Sales between a unitary pass-through entity and members of its unitary business group, as well as sales between unitary pass-through entities, are eliminated in computing the sales factor.

III. If group is not unitary, income generally is apportioned at partnership level.

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Illi iIllinois

I. Per 86 IAC 100.3380(d)(1): “Because partnerships may be members of a unitary business group … this provision requires a partnership to use combined apportionment when it is engaged in a unitary business with one or more of its partners."

II. But, partnership’s income and factors are not included if the business activities outside the U.S. are 80% or more of the total worldwide business activities of the partnership.

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MiMinnesota

I. Partnership income is subject to apportionment as business income of the unitary business when a unitary business relationship exists between the corporation and the partnership.

A. Partner does not need to own more than 50% direct ownership in the partnership to be included in the unitary business.

II. If the corporation and partnership are not engaged in a unitary p p p g g ybusiness, then the corporation must report its partnership income or loss as separately stated income or loss.

III However the Minnesota Supreme Court has held that a U S III. However, the Minnesota Supreme Court has held that a U.S. corporate partner’s distributive share of income and apportionment factors from a foreign partnership must be excluded from a Minnesota unitary group. Manpower v. Comm’r, 724 N.W. 2d 526 y g p p ,(Minn. 2006)

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Mi hiMichiganI. Michigan enacted retroactive legislation that provides that if an entity is a

disregarded entity (DRE) under the IRC, it will be disregarded for MBT purposes.

A. The law clarifies that if a DRE filed an original MBT return prior to Jan. 1, 2011 or an amended MBT return prior to Dec. 1, 2011 in which it was treated as a person separate from its owner it is not required to file amended MBT as a person separate from its owner, it is not required to file amended MBT returns as a division of its owner.

B. DREs that filed an original 2010 MBT return prior to Jan. 1, 2011 or an amended 2010 MBT return prior to Dec. 1, 2011 in which they were treated as p , ya person separate from its owner, can opt for separate treatment when filing the 2011 MBT return.

II. The law settles a controversy that arose from the 2009 Kmart decision.

1. In Kmart, the court held that DRE is a person under the SBT.

2. Department attempted to apply retroactively, but legislation prohibited that

3. Department then attempted to apply Kmart decision to MBT, requiring amended returns if DRE had been included in return with its owner.

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Brian Browdy, RyanDan Lapour, Moss Adams

FUTURE OUTLOOK ON

Dan Lapour, Moss AdamsMarianne Evans, KPMG

COMBINED REPORTING TRENDTREND

Who’sNext?StatesConsideringCombinedReporting

• Oklahoma

• TheadoptionofSJR61in2010establishedtheTaskForceonp JComprehensiveTaxReformchargedwithanalyzingthebusinessactivitytax(BAT)andrecommendingchangesfortaxyearsbeginningonorafterJan.1,2013.

• Thefinalreportofthetaskforce,issuedonDec.30,2011,recommendedenactmentofcombinedreportingforcorporatep g pincometaxpurposes.

• The report also recommended a corporate income tax rate reduction

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Thereportalsorecommendedacorporateincometaxratereductionfrom6%to5%.

Who’sNext?StatesConsideringCombinedReporting(Cont.)

• NewMexico

• SB9wouldhaverequiredunitarycorporationsthatprovideretailq y p psalesofgoodsinafacilityofmorethan30,000squarefeetunderoneroofinNewMexicotofileacombinedreturn.

• Italsowouldhavereducedthecorporateincometaxratefortaxpayerswithnetincomeover$1million,from7.6%to7.5%.

• ThegovernorvetoedthebillinMarch;thisactionhasbecomeabigpoliticalissueinNewMexico.

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• Maryland

• TheMarylandBusinessTaxReformCommissionevaluatedtheystate’sbusinesstaxstructureandrecommendedagainstimplementingcombinedreportinginthe2011session.

• SB305of2011andSB269of2012diedwithoutavoteintheBudgetgandTaxationCommittee.

• VirginiaVirginia

• TheHouseCommitteeonFinancevotedtotableHB1267inFebruary The bill would have required mandatory unitary combined

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February.Thebillwouldhaverequiredmandatoryunitarycombinedreporting.


• Proposedlegislationinotherstatesin2012

• Alabama:HB199

• Florida:SB1590

• Kentucky:HB162

• Missouri:HB1727

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Documents

Mandatory Combined Reporting for State Income Taxes