Mandatory Combined Reporting for State Income Taxes Improving Tax Compliance to Manage Conflicting State Rules

Transcription

1 Presenting a live 110-minute teleconference with interactive Q&A Mandatory Combined Reporting for State Income Taxes Improving Tax Compliance to Manage Conflicting State Rules WEDNESDAY, MAY 22, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Robert Rosato, Manager of State Income-Franchise Tax, Ryan, Pittsburgh Jeffrey Reed, Attorney, Mayer Brown, New York Mike Shaikh, Reed Smith, Los Angeles Robert Porcelli, Partner, State and Local Tax Group, PricewaterhouseCoopers, Tyson s Corner, Va. For this program, attendees must listen to the audio over the telephone. Please refer to the instructions ed to the registrant for the dial-in information. Attendees can still view the presentation slides online. If you have any questions, please contact Customer Service at ext. 10.

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5 Mandatory Combined Reporting for State Income Taxes Seminar May 22, 2013 Robert Rosato, Ryan Mike Shaikh, Reed Smith Jeffrey Reed, Mayer Brown Robert Porcelli, PricewaterhouseCoopers

6 Today s Program Overview Of Background Concepts And Trends [Robert Rosato] Mandatory Unitary Combined Reporting States [Mike Shaikh, Jeffrey Reed and Robert Porcelli] Slide 8 Slide 25 Slide 26 Slide 45 Discretionary Combined Reporting States [Jeffrey Reed and Mike Shaikh] Slide 46 Slide 52 Next States Likely To Act [Robert Porcelli] Slide 53 Slide 65

7 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS FIRMS 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 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 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 subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. 7

8 Robert Rosato, Ryan OVERVIEW OF BACKGROUND CONCEPTS AND TRENDS

9 State Filing Methodologies Separate company reporting Individual entity basis, with income of affiliates excluded Consolidated reporting Common ownership, usually 80% or more Some states require that a federal consolidated return be filed as a prerequisite to filing a state consolidated return. Single return filed for the affiliated group Combined reporting Common ownership, usually 50% or more Usually same trade or business Evidenced by functional integration, centralized management and economies of scale 9

10 Separate Company Reporting Filing separately The parent company and its affiliates are treated separately when determining taxable income. Nexus is analyzed with regard to each company's contacts with the state. LLCs are treated as taxable entities by some states. Separate company reporting is not common among the states. Some remaining separate reporting states have proposals to shift away from this methodology. 10

11 Consolidated Vs. Combined Reporting Consolidated reporting Similar basis of composition to federal filing group Generally, the affiliated group is treated as a single taxpayer. Focuses on ownership relationship between entities Usually, 80% common ownership requirement Business income often determined by post-apportionment Combined reporting Affiliates that are unitary are included in the group. Usually, 50% common ownership requirement 11

12 12 Combined Reporting Types of combined filing Mandatory combined reporting Roughly 20 jurisdictions require a unitary business to file a combined report. Unitary members are forced by statute to file a combined report. Elective/discretionary combined reporting Generally, these states also allow separate company returns. State requires or permits taxpayer to elect to file a combined report, if certain conditions are met. Combined report is used to accurately reflect group s income earned in the state. Nexus combination reporting All members with nexus in the state are included in return. States vary regarding pre- and post-apportionment of income.

13 Combined Reporting (Cont.) Pre-apportionment Members of the group combine income and losses before apportioning income. The combined business income of the entire group is multiplied using the entire group s aggregate apportionment percentage. Post-apportionment The income and losses of each member of the group are apportioned using each member s individual apportionment percentage. Each entity s apportioned income is aggregated afterward to determine the taxable income of the group. 13

14 Combined Reporting (Cont.) Unitary business States are limited by the U.S. Constitution when determining which entities are unitary. Fact-dependent analysis, often evidenced by factors including centralized management, functional integration and economies of Scale Determining which entities are unitary MTC regulations Three unities test Contribution and dependency test Flow of value test Factors of profitability test 14

15 Who Is The Taxpayer? Questions to consider: Who is ultimately included in the combined group? Whose apportionment factors are included in the combined group? Who can utilize the net operating losses generated within the combined group? Who can utilize credits generated within the combined group? 15

16 Who Is The Taxpayer? (Cont.) Worldwide reporting Combined return includes income from all foreign and domestic entities in the unitary group. Upheld by the U.S. Supreme Court in Container Corporation of America v. Franchise Tax Board, 103 S. Ct (1983) Water s edge election Taxpayer may exclude foreign members of the combined group that are not organized in the U.S. 16

17 Who Is The Taxpayer? (Cont.) 17 Joyce v. Finnigan Appeal of Joyce, Inc., No. 66 SBE 069 (Cal. SBE Nov. 11, 1966) A shoe company was unitary with a subsidiary in California but had no nexus in California. A unitary member without nexus to the taxing jurisdiction must remove its sales from the sales numerator, for apportionment purposes. A unitary member with nexus must throw back sales to jurisdictions where the member has no nexus. Appeal of Finnigan Corp., Cal. St. Bd. of Equal., August 25, 1988 Two taxpayers with nexus to California had sales outside California to a taxing jurisdiction where only one entity had nexus, All members of the unitary group include in-state sales in the apportionment numerator of a Finnigan state, Nexus based on the entire group: Sales by a member without individual nexus are not thrown back, because nexus was established by the entire group.

18 Who Is The Taxpayer? (Cont.) Throwback of sales Requires taxpayers that are not taxable in the destination state to source sales back to the state of origin Sales are thrown back into the numerator of the jurisdiction from which the goods were shipped. Reasoning behind throwback is to ensure that all sales are assigned to the numerator of a jurisdiction. Double-throwback Illinois throws back sales to its sales numerator when the taxpayer s activities in Illinois go beyond P.L , and the taxpayer s receipts are taxable in neither the destination state nor the origin state. 18

19 Who Is The Taxpayer? (Cont.) Credits Multiple approaches exist regarding application of credits to a unitary group. Some states only allow application of the credit to the entity that earned the credit, despite the unitary nature of the group. Other states allow application of the credit to any entity in the unitary group, though another entity in the group actually earned the credit. 19

20 Who Is The Taxpayer? (Cont.) Net operating losses NOLs can be treated as pre-apportioned losses carried forward for use by the entire group. Some states treat NOLs as a post-apportioned loss in the aggregate, for use by the entire group. Some states treat NOLs as a post-apportioned losses for each separate entity. Application of NOLs is limited in application to the entity that incurred the loss, not to other unitary entities. How are net operating losses allocated when members join or leave the group? What happens if a member converts to an LLC? 20

21 California Combined Reporting Update Recent changes in California California converts to Finnigan. All sales of the combined reporting group are included in the California sales numerator for apportionment purposes, regardless of a unitary member s nexus with the state. Single-sales factor apportionment For 2011 and 2012, taxpayers can elect to use single-sales factor apportionment or a double-weighted sales factor.» Election for 2011 and 2012 must be on a timely filed return and made by all entities in the combined group. In 2013, most taxpayers are required to use single-sales factor apportionment, including corporations in a combined group. 21

22 California Combined Reporting Update (Cont.) California law changes Economic nexus Cal. Rev. & Tax. Code 3101» A taxpayer is doing business in California if California sales exceed the lesser of $500,000 or 25% of its total sales. California Chief Counsel Ruling (Aug. 28, 2012) A taxpayer should not throw back sales to a jurisdiction where the taxpayer has greater than $500,000 of sales.» Having $500,000 of receipts in California creates economic nexus with California.» Despite another jurisdiction's statutes, $500,000 of sales into that jurisdiction creates economic nexus, for California throwback purposes. 22

23 State Throwback Updates Recent rulings and proposed laws Indiana sales to foreign countries subject to throwback A taxpayer s sales are thrown back when its business activities do not rise to the level of doing business in other states or foreign jurisdictions. Kentucky House Bill 142 Proposed bill would adopt a throwback rule, in addition to mandatory combined reporting, beginning on or after Jan. 1, Minnesota H.F. 37 Proposed bill would adopt throwback rule to sales of tangible personal property and services, beginning in

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25 Net Operating Loss Update Wisconsin NOL application Wis. Stat (6)(a) allows a post-apportioned NOL not used by a member of the combined group to be applied to other members of the combined group that can use the NOL. For taxable years after 2012, members of the combined group cannot share NOLs generated in tax years before Jan. 1, Beginning in tax year 2011 and for 19 years thereafter, an entity with a pre-2009 NOL may use that NOL against its own income, then use up to 5% of the pre-2009 NOL to offset income of other entities. 25

26 Mike Shaikh, Reed Smith Jeffrey Reed, Mayer Brown Robert Porcelli, PricewaterhouseCoopers MANDATORY UNITARY COMBINED REPORTING STATES

27 Massachusetts Regulations Unity presumptions/indicia Who s in the group Water s edge/worldwide election Domestic corporations plus certain foreign corporations REITs/RICs/captive insurance companies Computation of income Inter-company transactions ( ) Deferral regime Apportionment California method Finnigan Special rules Tax attributes 27

28 West Virginia MTC method Unity presumptions Who s in the group Water s edge/worldwide election Newly formed entities Insurance companies (out) Computation of income Inter-company transactions (conformity to Treasury Reg ) Deferred inter-company stock accounts Apportionment On a group basis Joyce Throw-out Tax attributes 28

29 District Of Columbia: Combined Reporting Mandatory unitary combined reporting was enacted effective Jan. 1, The final combined reporting regulations were finalized on Sept. 14, A corporation subject to tax must file a combined return if it is engaged in a unitary business with entities related by common ownership. Entities are commonly owned or controlled when more than 50% of the voting control of each member is directly or indirectly owned by a common owner or owners. 29

30 District Of Columbia: Combined Reporting (Cont.) Passive holding companies are deemed to be engaged in a unitary business if they (1) hold intangible assets used by the business, or (2) are parent companies that directly or indirectly control operating company subsidiaries. Unincorporated business entities are included in the combined return as members if they are more than 50% owned. 30

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32 Harley Davidson: Securitization Vehicles And Combined Returns Harley-Davidson, Inc. & Subs. v. California Franchise Tax Board Harley-Davidson offered a financing program to its dealers and to retail customers. The loans were packaged and were deposited into special purpose entity trusts (SPEs). The SPEs were established to be bankruptcy remote vehicles. The San Diego Superior Court ruled that the SPEs had nexus with California on the basis that they depended on Harley-Davidson entities for their existence, since their only business was to purchase loans for securitization. Accordingly, their factors were required to be included in the California combined return. Additionally, the court ruled that the SPEs were financial corporations, because they competed with national banks in selling pools of loans. 32

33 Chief Counsel Ruling Rulings: California Taxpayer does not have to throw back tangible personal property sales when it has more than $500,000 of sales in a foreign jurisdiction. Throwback of domestic tangible personal property sales is not required when a member of its California unitary group has more than $500,000 of sales, including sales of other than tangible personal property, in the destination state; and member is not otherwise protected from taxation in that state under P.L PwC Slide 33

34 Rulings: California (Cont.) Chief Counsel Ruling Certain corporations included in federal consolidated return converted to limited liability companies, as a result of filing under Chap. 11. Members of consolidated group were disallowed a worthless stock deduction on conversion of insolvent corporations under Treas. Reg. Sec (d)-2(a)(1). FTB held that because California does not permit a consolidated return, Treas. Reg. Sect (d)-2(a)(1) will not operate to disallow any worthless stock deduction pertaining to insolvent converted entities, otherwise applicable under federal consolidated rules. PwC Slide 34

35 Cases: California Apple, Inc. v. Franchise tax Board, Cal. Circuit Ct., Dkt. Nos. A128091, A129090, 9/12/2011; Cal. S. Ct., Dkt. No. S197381, petition for review denied 01/04/2012 Dividends from the accumulated earnings of a partially included CFC of a water s edge filer are governed by the last-in/first-out ordering provisions and must be treated as coming from current-year earnings until exhausted, and then from the most recent years earnings without regard to whether the earnings represent included or excluded income. Interest expense attributable to funds proven to have some economic connection to the generation of taxable income qualify for deduction. PwC Slide 35

36 Cases: Illinois Clarcor, Inc. v. Hamer, Ill Ct. App., No. 09-L-51291, 5/11/12 The court rejected taxpayer s attempt to exclude its packaging subsidiaries from its unitary group, while not attempting to exclude its filtration subsidiaries. Court found that horizontal integration existed between the subsidiaries, as evidenced by the sharing of cash, which is strongly indicative of a unitary business; and common pension, 401(k) and health insurance plans. Further, the taxpayer offered no explanation of why it lacked vertical control over the subsidiaries it sought to exclude. PwC Slide 36

37 Cases: Minnesota Express Scripts, Inc. v. Commissioner of Revenue, Minnesota Tax Court, Ramsey County, Docket No. 8272R, 8/20/12 A taxpayer s corporate acquisition triggered an IRC Sect. 382 limitation of the acquired company s net operating loss carryovers equal to approximately $30 million. The Minnesota Department of Revenue apportioned that limitation using the apportionment ratio of the income years, which reduced the amount of available loss to approximately $120,000. Despite department guidance to the contrary, there was no statutory authority for the department s position to apportion the Sect. 382 limitation. Additionally, the Tax Court found that the taxpayer was not unitary with one of its LLC subsidiaries, because the facts did not support a flow of value and there was not sufficient control over the subsidiary. PwC Slide 37

38 Cases: Texas In re: Nestle USA, Inc., 387 S.W.3d 610 (Tex. Oct. 19, 2012), rehearing denied Dec. 14, 2012 Challenge involving constitutionality of Texas franchise tax under Texas Equal and Uniform Clause and the Equal Protection, Due Process and Commerce Clauses Texas Supreme Court dismissed without merit all constitutional challenges made to the Texas franchise tax, finding that the Legislature has discretion in structuring tax laws and the structure of the franchise tax is reasonably related to the value of the privilege of doing business in Texas. Reinforced Texas position that a combined group is subject to a single classification, for deduction purposes, regardless of separateentity benefit. PwC Slide 38

39 Costco Wholesale Corp. v. Oregon Department of Revenue Bermuda insurance company not independently subject to tax or required to file in Oregon. Held insurance company income required to be in included in group income Compare with Stancorp Oregon Tax Court, TC

40 Coca-Cola Enterprises, Inc. v. Alabama Department of Revenue Consolidated group filing Issue of whether the group can carry forward NOLs incurred before an election to file consolidated return Application of SRLY rules Held: Group may carry forward NOLs before election but may not deduct losses incurred before consolidated filing was an option. Docket No. Corp

41 Inclusion Of Foreign Entities In Combined Returns Most states provide for water s edge combined reporting or worldwide combined reporting as a default, and water s edge combined reporting may be elected. In some states, all foreign corporations (i.e., corporations incorporated in foreign countries) are excluded from the combined return. In other states, at least some foreign corporations are included in the combined return. 41

42 Inclusion Of Foreign Entities In Combined Returns (Cont.) If 20% or more of a foreign corporation s activity is in the U.S., then some states will require that it be included in the unitary combined return. Some states will look to the average property and payroll. Other states look to the average property, payroll and sales. Wisconsin looks to whether 80% active foreign business income. Some states will include foreign corporations, to the extent of ECI or FDAP. 42

43 Inclusion Of Foreign Entities In Combined Returns (Cont.) Recently, a few states have started including foreign corporations if more than 20% of the income of the foreign corporation is from intangible property or service-related activities, the costs of which are deductible against the business income of other members of the unitary group (DC, MA and WV). A few states include foreign corporations in the combined return if they are doing business in a tax haven jurisdiction (AK, DC, MT and WV). 43

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45 What s In the Group? Insurance companies REITs/RICs/REMICs 45

46 Jeffrey Reed, Mayer Brown Mike Shaikh, Reed Smith DISCRETIONARY COMBINED REPORTING STATES

47 Discretionary Combined Separate-entity state Reporting: New York Old law: Combined if distortion Presumption of distortion if substantial intercorporate transactions between the companies If no substantial inter-corporate transactions, may be required or permitted to file combined if separate-entity reporting would not fairly reflect the income of the corporations 47

48 New law: Discretionary Combined Reporting: New York (Cont.) Must file combined if there are substantial inter-corporate transactions TSB-M-08(2)C details how to determine if there are substantial intercorporate transactions. Receipts test Expenditures test Asset transfer test Loans included but not dividends Recent trend toward decombination audits IT USA, Inc. 48

49 North Carolina History of forced combination Wal-Mart East v. Hinton (2009) Delhaize America, Inc. v. Lay (2012) North Carolina Directive CD Codification of forced combination 49

50 Discretionary Combined Reporting: Indiana In Indiana, combined reporting is viewed as an alternative to three-factor apportionment. So, combined reporting may be invoked by the Indiana DOR or by taxpayers as a type of alternative apportionment. Combined reporting is warranted to fairly reflect a taxpayer s Indiana income. Indiana Code Penalties Burden of proof issues 50

51 South Carolina Combination Media General Communications, Inc. v. S.C. Department of Revenue, (S.C. Supreme Court 2010) Burden of proof CarMax Auto Superstores West Coast, Inc. v. South Carolina Department of Revenue (S.C. Court of Appeals 2012) 51

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53 Robert Porcelli, PricewaterhouseCoopers NEXT STATES LIKELY TO ACT

54 Combined Reporting: 2001 WA OR ID MT WY ND SD MN WI MI NY VT NH MA CT ME RI CA NV UT CO NE KS IA MO IL IN OH KY WV PA VA NJ DE MD DC AZ NM OK AR TN NC SC AK MS AL GA TX LA HI FL Combined reporting proposals Unitary/combined states Remaining separate entity or elective consolidated reporting/other PwC Slide 54

55 Combined Reporting: 2013 WA OR ID MT WY ND SD MN WI MI NY* VT NH MA CT ME RI CA NV UT CO NE KS IA MO IL IN OH KY WV PA VA NJ DE MD DC AZ NM* OK AR TN NC SC AK MS AL GA TX LA HI FL Combined reporting proposals considered recently and/or currently proposed Unitary/combined states (now including the Ohio CAT, Texas margin tax and Michigan business tax) Remaining separate entity or elective consolidated reporting/other * New Mexico requires certain unitary large retailers to file combined returns (2014). PwC * New York requires related corporations to file a combined report upon the existence of substantial intercorporate transactions Slide 55

56 Combined Reporting Vermont applies to tax years beginning on or after January 1, 2006 West Virginia any taxpayer engaged in a unitary business with one or more other corporations must file a combined report, effective Jan. 1, 2009 Ohio CAT consolidated or combined reporting required Texas margin tax taxable entities that are part of an affiliated group engaged in a unitary business must file a combined report Michigan taxpayers are required to file based on a unitary combined reporting system, effective Jan. 1, 2008 (MBT) and effective Jan. 1, 2012 (corporate income tax) Massachusetts adopted combined reporting, effective Jan. 1, Wisconsin adopted combined reporting, effective for tax years beginning on or after Jan. 1, District of Columbia applies to tax years beginning after Dec. 31, 2010 PwC Slide 56

57 Combined Reporting Legislation: 2012 Activity Alabama S.B. 333, indefinitely postponed 4/26/12 Florida S.B. 1590, died in committee 3/9/12 Kentucky H.B. 162, introduced 1/3/12 (repeal mandatory nexus consolidation enacted in 2005 no activity since introduced) Maryland H.B. 941, 2/10/12 (no action) New Mexico S.B. 9, vetoed 3/6/12 Pennsylvania H.B. 2383, introduced 5/16/12 Virginia H.B (postponed until 2013) PwC Slide 57

58 Combined Reporting Legislation: 2013 Activity (Cont.) Alabama H.B. 203, pending committee action 2/7/13 Maryland H.B. 1246, failed Montana S.B. 208, introduced 1/28/13 (repeal water sedge election), died in standing committee 4/24/13 New Mexico S.B. 13, introduced 1/15/13 PwC Slide 58

59 Proposal: California On July 25, 2013, the California Franchise Tax Board will hold a public hearing regarding proposed modifications to California Code of Regulations Sect , specifically pertaining to the treatment of deferred inter-company stock accounts (DISAs). Proposed changes include: Reduction of a DISA through merger with a brother/sister corporation with basis Reduction of a DISA through subsequent capital contribution Treatment of a distribution through various tiers of stock ownership Does not currently address certain issues with respect to triggering a DISA, including a liquidation in a combined group PwC Slide 59

60 Proposal: Illinois On March 6, 2013, Illinois Gov. Pat Quinn proposed three corporate income tax changes: Suspending the foreign dividend deduction Decoupling from the federal domestic production activities deduction Suspending the non-combination rule for unitary members with different apportionment formulae That same day, Senate Bill 159 was amended to incorporate these three proposed changes, including repeal of the non-combination rule, which would be effective for tax years ending on or after Dec. 31, PwC Slide 60

61 Proposal: Massachusetts Gov. Patrick proposed budget, 1/23/13 Switch to market-based sourcing for sales of other than tangible personal property (also in HB 3382) Adopt throw-out rule for sale of other than tangible personal property (also in HB 3382) Repeal of security and utility classifications (utility classification provision also in HB 3382) Repeal of FAS 109 deduction: o The 2008 tax package established a deduction for any combined group that experienced an increase in the group s net deferred tax liability as a result of the combined reporting requirements of unitary businesses. The deduction, which will be claimed over a seven-year period, was to take effect for tax years beginning in o H.B delayed the implementation of the deduction for one year, by allowing deductions to first be claimed in PwC Slide 61

62 PwC Proposal: Minnesota S.B. 552 and FY budget proposal Legislation provides that foreign operating corporations (FOCs) would no longer be excluded from filing a Minnesota return or from filing as members of a unitary group. Provisions regarding FOCs would be repealed, including the deemed dividend provision and the 80% royalty deduction (presumably because FOCs would file as members of a unitary group). Legislation would repeal the royalty deduction from any other foreign corporation (currently at 80%). The legislation would provide that income and apportionment factors of a foreign entity would flow to its unitary domestic owner, for purposes of calculating net income and apportionment factors of a unitary business, to the extent the income is included in federal taxable income. Adopts Finnigan for purposes of sourcing sales of the unitary group Slide 62

63 Proposal: Montana Montana S.B. 208 Died April 24, 2013 in standing committee Would have (1) removed the taxpayer election to report as a water s edge group, and (2) required worldwide combined reporting for a unitary group of taxpayers Water s edge elections made prior to the bill s effective date would have remained in effect until its three-year term expired. PwC Slide 63

64 Proposal: Pennsylvania S.B. 882, regular session Imposes mandatory combined reporting requirement Water s edge treated as default classification; worldwide allowed upon election No guidance on Joyce/Finnigan contained within legislation Combined reporting effective for years beginning after Dec. 31, 2018 PwC Slide 64

65 Proposal: Oregon S.B. 310, referred to Finance and Revenue Committee 1/16/13 Adopt Finnigan approach for apportionment Governor s executive budget and A.B. 3009, S.B. 2609, introduced 1/22/13 S.B. 311, referred to Finance and Revenue Committee 1/16/13 Adopt market-based sourcing for sales not involving tangible personal property PwC Slide 65