State & Local Tax Alert

Transcription

1 State & Local Tax Alert Breaking state and local tax developments from Grant Thornton LLP Iowa Supreme Court Rejects Inclusion of Parent Company in Consolidated Report On March 24, 2017, the Iowa Supreme Court affirmed a District Court decision that a group s parent company could not be included with its subsidiaries in an Iowa consolidated income tax return because the parent did not receive taxable Iowa income. 1 Rather, the parent s activities in Iowa consisted of owning and controlling the subsidiaries, and this activity does not establish a taxable nexus with Iowa. While Iowa law allows corporate groups to file a nexus consolidated income tax return, a corporation is allowed to join in the filing of the consolidated return only if it has taxable Iowa source income. Background Iowa law imposes its income tax on corporations doing business in this state, or deriving income from sources within this state. 2 During the 2009 tax year, Myria Holdings Inc., a Delaware corporation with its primary place of business in Texas, filed a consolidated Iowa income tax return with two of its subsidiaries doing business in Iowa: Natural Gas Pipeline Company of America LLC ( NGPL ) and NGPL PipeCo LLC ( PipeCo ). For federal income tax purposes, both NGPL and PipeCo had elected to be treated as corporations. During the tax year at issue, Myria and its subsidiaries (Group) were in the business of natural gas pipeline transmission and storage. NGPL owned and operated a major natural gas transmission and storage system, which operated in part in Iowa. PipeCo owned real and personal property in Iowa and leased it to NGPL. Myria held an 80 percent membership interest in PipeCo and PipeCo was the sole member of NGPL. Myria had no employees and it did not own or lease any real or personal property in Iowa. However, Myria owned the two subsidiaries that operated in Iowa and assisted them with strategic planning. Myria received two types of payments from its subsidiaries; which paid Myria distributions of earnings and quarterly payments of each member s allocated tax liability. The distributions of earnings were tied to Myria s ownership interest in the subsidiaries and the payments of tax liability were allocated in accordance with a tax allocation agreement that apportioned to each member its portion of the Group s tax liability. Release date May 3, 2017 States Iowa Issue/Topic Corporate Income Tax Contact details Dan Bartholet T E dan.bartholet@us.gt.com Dale Busacker T E dale.busacker@us.gt.com Caroline Balfour T E caroline.balfour@us.gt.com Emily Miller T E emily.miller@us.gt.com Jamie C. Yesnowitz Washington, DC T E jamie.yesnowitz@us.gt.com Chuck Jones Chicago T E chuck.jones@us.gt.com Lori Stolly Cincinnati T E lori.stolly@us.gt.com Priya D. Nair Washington, DC T E priya.nair@us.gt.com 1 Myria Holdings Inc. v. Iowa Department of Revenue, Iowa Supreme Court, No , March 24, IOWA CODE (1)..

2 Grant Thornton LLP - 2 During the year at issue, Myria prepared, filed, and paid the Group s federal consolidated income tax liability even though each subsidiary assumed its own tax liability and agreed to indemnify Myria against any of the subsidiary s individual tax liabilities. The Group filed an Iowa consolidated return for While NGPL had taxable income, the Group s consolidated Iowa income for the year resulted in an apportioned net loss and Myria had no Iowa sales. The Iowa Department of Revenue issued an order taking the position that Myria was ineligible to be included in the 2009 consolidated return on the basis that Myria did not receive taxable Iowa income under Iowa Code Sec (1). The resulting assessment substantially increased the Iowa taxable income of the remaining members of the Group and assessed over $2.5 million of additional tax, penalties, and interest. The Group protested the assessment before an Iowa administrative law judge (ALJ). The ALJ issued a proposed decision upholding the Department s assessment. In the Department s final order, it determined that Myria s activities in Iowa and the distributed earnings that it received from its subsidiaries were incidental to its ownership interest and consisted of [o]wning and controlling a subsidiary corporation, 3 not doing business in the state or deriving income from sources within the state. 4 Owning and controlling a subsidiary corporation constitutes a safe harbor activity under the statute which provides an Iowa income tax exemption for corporations located outside Iowa and which have no physical presence in the state. The Iowa District Court for Polk County subsequently affirmed the Department s final order. The Group appealed the District Court s decision to the Iowa Supreme Court. Parent Corporation Located Outside State Lacks Nexus in Iowa In determining that Myria did not have nexus with Iowa, the Iowa Supreme Court provided a detailed analysis of the statutory nexus safe harbor of owning and controlling a subsidiary corporation for out-of-state corporations without a physical presence in Iowa. 5 A parent company is not required to be included in an Iowa consolidated return. Rather, it may designate a subsidiary to file on the group s behalf if the parent entity is not doing business in this state, or deriving income from sources within this state. 6 An entity may only join a group s Iowa consolidated return if the entity has both taxable nexus in the state and taxable net income. 7 Taxable Income The Group s primary argument was that Myria received taxable Iowa income within the meaning of Iowa Code Sec (1) during 2009 because it received distributions of earnings which were traceable back to its Iowa subsidiaries and tax payments from these 3 See IOWA CODE A(5). 4 See IOWA CODE (1). 5 IOWA CODE A(5). 6 IOWA CODE (1); see IOWA ADMIN. CODE r (1). 7 Id.

3 Grant Thornton LLP - 3 subsidiaries. Myria considered the tax payments a working capital cushion because the subsidiaries made payments on a quarterly basis rather than a daily basis. An important fact however, was that PipeCo and NGPL did not pay Myria interest, fees for service, or any other fees associated with the tax payments. The Court held that these payments did not create a taxable nexus with Iowa because the payments were equal to the subsidiaries allocated share of the Group s overall tax liability. The timing difference Myria afforded its subsidiaries on the tax payments was merely the exercise of the activity of ownership and control of the subsidiaries, which is an exempt activity under the statute. Owning and Controlling a Subsidiary Corporation In considering whether Myria s activities in Iowa fell within the safe harbor of owning and controlling a subsidiary corporation within the meaning of Iowa Code Sec A(5), the Court assigned the common, ordinary meaning of the terms owning and controlling because they are not defined in the statutes or interpreted by regulations. 8 The Group argued that its activities in Iowa, when considered in the aggregate, went beyond the safe harbor of owning and controlling a subsidiary corporation because part of the strategic planning Myria provided to PipeCo and NGPL included significant managerial, administrative, and financial support. However, the Court found that all of Myria s activities were routine activities pursuant to the common meaning of what constitutes ownership and control of a subsidiary. Alternative Basis for Nexus Finally, the Group argued that Myria had taxable nexus in Iowa because it owned intangible property with a situs in Iowa: shares of stock and money. The Court questioned whether an interest in an LLC could be considered shares of stock. 9 Assuming arguendo, the Court held that certificates cannot by themselves remove a company from the nexus safe harbor of Iowa Code Sec A(5). Additionally, the Court rejected the Group s situs of money argument because the payments were property of the subsidiaries transferred to Myria under the tax allocation agreement which Myria paid to the taxing authority. Iowa Supreme Court KFC Corp. Decision Distinguishable According to the Court, the Department correctly concluded that its KFC Corp. v. Iowa Department of Revenue 10 decision was distinguishable and was not applicable to Myria s facts. In KFC, the Court held that when an out-of-state corporation licensed its intellectual property to in-state entities, this activity created taxable nexus in Iowa. However, in this case, the Court found that Myria received no royalty payments, license fees, or other earned fees in connection with the Group s business in Iowa. As a result, the Court 8 See Bank of Am., N.A. v. Schulte, 843 N.W.2d 876, 880 (Iowa 2014). 9 See IOWA ADMIN. CODE r (1)(d) N.W.2d 308, 328 (Iowa 2008).

4 Grant Thornton LLP - 4 determined that Myria lacked taxable nexus in the 2009 tax year because Myria satisfied the nexus safe harbor for out-of-state corporations. 11 The Court concluded that, because Myria did not otherwise established a taxable nexus in the state for the 2009 tax year, it could not join the consolidated return. Commentary Despite the existence of a nexus statute that specifies numerous situations in which a corporation will be deemed not to have Iowa nexus, the Department has long had a reputation for aggressively making nexus assertions against out-of-state companies. In 2010, the Iowa Supreme Court aggressively applied an economic nexus standard in the KFC decision in which the Court decided that Iowa could tax KFC because it received royalties from independent franchisees doing business in Iowa to whom KFC had licensed its trademarks. In this case it appears that the Court shied away from applying the economic nexus standard and instead broadly applied at least one of Iowa s statutory nexus safe harbors which were enacted to protect out-of-state corporations without physical presence within the state. Normally, corporations would welcome the broad application of a nexus safe harbor statute in order to prevent the imposition of the Iowa corporation income tax, but in this instance, the elimination of Myria from the consolidated filing group resulted in a significant assessment. Query whether the result in this case would have been different if Myria had received royalty payments from its subsidiaries because it had licensed some intangible assets to them. In order to be able to elect to file a consolidated income tax return in Iowa, each entity must have taxable nexus with that state. Taxpayers must carefully review the different filing requirements provided by each state when they desire to elect to use a consolidated filing election. In addition, it is interesting to speculate how different the answer would have been for this taxpayer if the LLCs involved had instead been treated as flow-through entities for federal income tax purposes rather than electing to be treated as corporations. The information contained herein is general in nature and based on authorities that are subject to change. It is not intended and should not be construed as legal, accounting or tax advice or opinion provided by Grant Thornton LLP to the reader. This material may not be applicable to or suitable for specific circumstances or needs and may require consideration of nontax and other tax factors. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Grant Thornton LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. No part of this document may be reproduced, retransmitted or otherwise redistributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, re-keying or using any information storage and retrieval system without written permission from Grant Thornton LLP. 11 IOWA CODE A(5).

5 Grant Thornton LLP - 5 This document supports the marketing of professional services by Grant Thornton LLP. It is not written tax advice directed at the particular facts and circumstances of any person. Persons interested in the subject of this document should contact Grant Thornton or their tax advisor to discuss the potential application of this subject matter to their particular facts and circumstances. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed.