State & Local Tax Alert

Transcription

1 State & Local Tax Alert Breaking state and local tax developments from Grant Thornton LLP Minnesota Supreme Court Affirms Inclusion of Foreign Disregarded Entities in Combined Report On August 2, 2017, the Minnesota Supreme Court affirmed a Tax Court decision that the Department of Revenue had improperly adjusted a taxpayer s combined Minnesota taxable income to exclude income and apportionment factors of a foreign subsidiary that had elected to be disregarded for federal income tax purposes. 1 Specifically, the Court determined that Minnesota s income tax law could be reconciled with the taxpayer s federal income tax election to disregard a foreign entity, resulting in the inclusion of the disregarded foreign entity in the taxpayer s combined income tax report. Background In November 2008, Ashland Inc., headquartered in Kentucky, acquired Hercules Inc. ( Hercules ), a C corporation organized under Delaware law. As a wholly-owned subsidiary of Ashland, Hercules was included as a member of Ashland s federal consolidated income tax returns and its combined reports for Minnesota corporate franchise (income) tax purposes for the tax years. Hercules owned 100 percent of Hercules SARL ( Hercules SARL ). Hercules SARL was a foreign entity, organized under the laws of Luxembourg. As of June 29, 1999, Hercules SARL elected on federal Form 8832, Entity Classification Election, to be treated as a disregarded entity. 2 For federal income tax purposes, the election resulted in a deemed liquidating distribution of all of Hercules SARL s assets and liabilities to its sole shareholder, Hercules. 3 This liquidation was deemed to occur on June 28, 1999, immediately before the close of the day on which the election became effective. 4 Thus, for federal income tax purposes, as a disregarded entity, the activities and income or loss of Hercules SARL were treated as that of its domestic parent, Hercules. For Ashland s combined Minnesota tax returns, Hercules SARL s income, losses, deductions, and apportionment factors were reported as belonging to Hercules. Release date August 15, 2017 States Minnesota Issue/Topic Corporate Income Tax Contact details Dale Busacker T E dale.busacker@us.gt.com Bill Lunka T E bill.lunka@us.gt.com Caroline Balfour T E caroline.balfour@us.gt.com Christopher P. Martin T E christopher.martin@us.gt.com Emily Miller T E emily.miller@us.gt.com 1 Ashland Inc. v. Commissioner of Revenue, Minnesota Supreme Court, A (Aug. 2, 2017). For a discussion of the previous decision, see GT SALT Alert: Minnesota Tax Court Approves Inclusion of Foreign Disregarded Entities in Combined Report. 2 See Treas. Reg (a). 3 Treas. Reg (g)(1)(iii). 4 Treas. Reg (g)(3)(i)..

2 Grant Thornton LLP - 2 In February 2015, the Minnesota Commissioner of Revenue issued an order that excluded the income or loss and the apportionment factors of Hercules SARL from Ashland s Minnesota combined tax returns on the basis that the SARL was a foreign entity. The audit report increased Hercules s income for two of the three years at issue because Hercules SARL had losses in those two years. The Commissioner s order assessed nearly $1.2 million of additional tax, penalties, and interest. Ashland appealed the Commissioner s order directly to the Minnesota Tax Court, forgoing an administrative appeal. In June 2016, the Tax Court granted Ashland s motion for summary judgment and held that Ashland had properly included Hercules SARL s income or losses and its apportionment factors in its Minnesota combined returns because of the election to disregard the entity for federal income tax purposes and, by extension, for Minnesota income tax purposes. The Commissioner appealed this decision to the Minnesota Supreme Court. Specifically, the Commissioner asked whether the Tax Court had properly applied the Minnesota statutes to determine the composition of Ashland s combined report. Foreign Disregarded Entity Includible in Combined Report At issue was whether the income, losses, and deductions of Hercules SARL could be included in computing Ashland s Minnesota combined taxable income Ultimately, the Minnesota Supreme Court agreed that the Commissioner had no basis to reject the foreign entity s election to be treated as a disregarded entity and to exclude Hercules SARL s activities from Ashland s Minnesota combined returns. The fact that Hercules SARL remained a separate legal entity was irrelevant because the election to be disregarded was deemed to be a distribution in liquidation of Hercules SARL s assets and liabilities to Hercules and Hercules SARL ceased to exist for federal income tax purposes. Minnesota Statutes Reconciled The Court began its analysis by considering the interplay between two separate and seemingly contradictory Minnesota statutes. During the tax years at issue, Minnesota s water s edge combined reporting law prohibited the income, loss, or apportionment factors from foreign corporations or entities which were part of a unitary business from being included in a Minnesota combined report, only allowing income, loss, or apportionment factors from domestic entities. 5 However, Minnesota law also provided that the state would follow any elections made by the taxpayer in accordance with the Internal Revenue Code in determining federal taxable income for federal income tax purposes. 6 The Court has broadly interpreted the word any 7 and it applied that broad application to include Hercules SARL s federal check the box election to be disregarded. As a result, the Court agreed with the Tax Court s conclusion that once the election to be 5 Former MINN. STAT , subd. 4(f). Note that this statute was amended in As amended, the income and apportionment factors of a foreign entity (other than an entity treated as a C corporation) that are included in the federal taxable income of a domestic corporation or entity must be included in the net income and apportionment factors of the unitary business. 6 MINN. STAT , subd. 19. (Emphasis added). 7 Hyatt v. Anoka Police Department, 691 N.W.2d 824 (Minn. 2005).

3 Grant Thornton LLP - 3 treated as a disregarded entity became effective, Hercules SARL is deemed no longer an entity separate from Hercules and, accordingly, the income and apportionment factors of Hercules SARL are deemed to be part of the income and apportionment factors of Hercules itself, a domestic corporation. 8 This reasoning allowed the Tax Court to harmonize the law which excluded foreign entities from being included in the combined report with Minnesota s statutory requirement to respect elections made for federal income tax purposes. Minnesota Supreme Court s Manpower Decision Distinguishable The Court further rejected the Commissioner s broad application of its decision in Manpower, Inc. v. Commissioner, 9 which, the Commissioner asserted, would require Hercules SARL s activities to be excluded from Ashland s Minnesota combined returns. In Manpower, the Minnesota Supreme Court rejected the inclusion in Manpower s Minnesota combined report of a French SARL which had elected to be treated as a partnership instead of a corporation. The election of a foreign entity to be treated as a partnership for federal income tax purposes meant that, since the foreign entity was treated as a partnership, it was still a separate regarded entity for tax purposes distinct from its partners. As a result, the French SARL was excluded from the combined report since it was a foreign entity. According to the Court, its decision in Manpower was distinguishable and not applicable to Ashland s facts because, in Manpower, it had not addressed the effect of an election to be treated as a disregarded entity. When Hercules SARL became a disregarded entity for income tax purposes, it was deemed to have distributed all of its assets to its sole shareholder, Hercules, which was a domestic entity. Therefore, Hercules SARL ceased to exist on its own and became part of its domestic owner, Hercules for income tax purposes on June 29, 1999, years before Ashland acquired Hercules. As a result of the federal election to be disregarded, Hercules SARL was deemed to be either a division or a liquidated asset of its parent company, Hercules, a domestic entity. Revenue Notice Not Applied Finally, the Court declined to apply the position taken by the Department in Revenue Notice 98-08, even though it was in effect during the tax years at issue. In Revenue Notice 98-08, the Department took the position that Minnesota did not recognize the check the box election made by a foreign eligible entity with a single C corporation owner which is electing to be disregarded as a separate entity for federal tax purposes. 10 The Court noted that Revenue Notices are not binding because they do not have the force and effect of law. 11 Further, when statutory language is clear, administrative interpretations do not 8 Ashland Inc. v. Commissioner of Revenue, No R, 2016 WL , (Minn. T.C. June 27, 2016) N.W.2d 526 (Minn. 2006). 10 Revenue Notice 98-08, Minnesota Department of Revenue, May 26, In 2013, this notice was replaced by Revenue Notice 13-08, Minnesota Department of Revenue, Dec. 23, MINN. STAT. 270C.07, subd. 2.

4 Grant Thornton LLP - 4 control. 12 Rather, revenue notices are simply meant to provide general guidance to the public on the Department s position on an issue. 13 In this case, the election to disregard Hercules SARL meant that it was not a foreign entity because it was deemed to have liquidated all of its assets and liabilities to Hercules as of June 28, As a result of making the election to be disregarded, the Court determined that the net income and apportionment factors of Hercules SARL belonged to Hercules, which was a domestic entity and properly included in the Minnesota combined income report. Commentary During the tax years at issue, Minnesota law clearly barred the inclusion of the net income and apportionment factors of foreign corporations and other foreign entities in determining the net income and apportionment factors of the unitary business for combined reporting purposes. 14 However, the law was changed beginning with the 2013 tax year to require the inclusion in the unitary group of the income and apportionment factors of foreign entities that are disregarded for federal income tax purposes. 15 Because the law has been amended, the decision in this case only applies to tax years prior to This affirmation by the Minnesota Supreme Court of the Tax Court s decision further solidifies a potential opportunity for certain taxpayers for open tax years prior to Specifically, taxpayers who previously excluded the income or loss and apportionment factors of foreign disregarded entities from their Minnesota combined report in reliance on the Department s position in Revenue Notice should carefully review their facts. If they benefit from this decision, they should consider filing refund claims with the Department before the related statute of limitations closes. This issue will be of particular significance for taxpayers with material operations in foreign entities that are disregarded for federal income tax purposes, and which are currently involved in lengthy federal or Minnesota corporate income tax audits. 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. 12 Hutchinson Tech., Inc. v. Commissioner of Revenue, 698 N.W.2d 1 (Minn. 2005). 13 MINN. STAT. 270C.07, subd Former MINN. STAT , subd. 4(f). 15 MINN. STAT , subd. 4(f), as amended by Ch. 143 (H.F. 677), Laws 2013, effective for tax years beginning after Dec. 31, 2012.

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.