mandatory combined reporting for state income...

Mandatory Combined Reporting for State Income Taxes

presents Improving Tax Compliance to Manage Conflicting State Rulespresents

A Live 110-Minute Teleconference/Webinar with Interactive Q&AToday's panel features:

Joe Neff, National Managing Director, State and Local Tax, RSM McGladrey, Los AngelesMary Bernard, Tax Principal and Director of State and Local Tax Services, Kahn Litwin Renza & Co., Providence, R.I.

Howard Wagner, Executive, Crowe Horwath, Louisville, Ky.Bob Carleo, Director, Deloitte & Touche, Boston

Thursday, March 4, 2010

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Mandatory Combined Reporting For State Income

Taxes TeleconferenceTaxes Teleconference

March 4, 2010,

Joe Neff, RSM [email protected]

Mary Bernard, Kahn Litwin Renza and [email protected]

Howard Wagner, Crowe Horwathhoward wagner@crowehorwath com

@

Robert Carleo, Deloitte Taxrcarleo@deloitte [email protected] [email protected]

Today’s ProgramToday s ProgramCombined Reporting Background Trends Slides 3-24

Combined Reporting Systems In Massachusetts Slides 25-44

Wisconsin’s Combined Reporting System Slides 45-55p g y

Combined Reporting In California And Illinois Slides 56-64

Combined Reporting In Michigan Slides 65-70Combined Reporting In Michigan Slides 65-70

Combined Reporting In Texas, New York, Ohio And West Virginia Slides 71-100And West Virginia Slides 71 100

Future Outlook Slide 101

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Combined Reporting B k d T dBackground Trends

Joe Neff, RSM [email protected]@rsmi.com

Manditory Unitary CombinedManditory Unitary Combined Reporting (MUCR), Overview Overview of combined reporting Why the new wave of combined y

reporting What it is, what it means State-specific updates

Wisconsin, Connecticut, Massachusetts and New York

4

MUCR O i (C t )MUCR Overview (Cont.)

Trend: Seven states have adopted combined reporting since 2004. Prior to 2004, no state had adopted combined reporting for twohad adopted combined reporting for two decades.

Vermont (2004) Ohi * (2005) Ohio* (2005) Texas* (2006) West Virginia, New York and Michigan* (2007)g , g ( ) Massachusetts (2008) Wisconsin (2009)

5


Michigan, Ohio and Texas* have gadopted some form of mandatory unitary combined reporting recently, but all are i th t t f i t h b idin the context of gross receipts or hybrid business taxes.

6


Rationale for adoption Generation of revenue Various state case studies of estimated Various state case studies of estimated

increase in annual state revenue range from a 3% increase in corporate income tax revenue (study conducted in Maryland in 2007) to a ( y y )20% increase (study conducted in New Mexico in 2008).

The only available post-implementation study, d t d b Mi t i 1984 i t lconducted by Minnesota in 1984 using actual

tax return information, indicated no change in state revenue from corporate income tax.

7


Rationale for adoption (Cont.) Elimination of tax avoidance planning: Alternative

approaches to combating tax avoidance — such as disallowance of deductions related to intangibles expenses paid to affiliates and imposition of taxing jurisdiction on out-of-state affiliates of in-state taxpayers (Geoffrey v South Carolina Tax Commission) such as(Geoffrey v. South Carolina Tax Commission), such as REIT’s (Wal-Mart Stores East, Inc., v. Wake County) —have proven less successful and are susceptible to sophisticated tax planning.

Sixteen states — AL, AR, CT, DC, GA, IN, KY, MD, MA, MS, NJ, NC, OH, RI, SC and VA — have adopted statutes requiring taxpayers to add back to incomecertain expenses paid to related partiescertain expenses paid to related parties.

8


Rationale for adoption (Cont.) Leveling of playing field for g p y g

corporations doing business wholly within a state

Advocates of combined reporting believe that true level of economic

ti it f ti i dactivity of a corporation is measured only through combined reporting, without regard to corporate structurewithout regard to corporate structure.

9


Rationale for adoption (Cont.) Arguments against combined reporting

requirementq Improper taxation of extra-territorial income,

which creates incentives for multi-state corporations not to do business in state, pthereby impairing economic growth within adopting states

Onerous administrative burden, particularly ith t t d t i ti f hi h titiwith respect to determination of which entities

with a corporate group are to be included in and excluded from combined report

10

MUCR Global Issues: InstantMUCR Global Issues: Instant Unity

When is a newly acquired corporation to be included in the combined unitary return of the acquiring group?acquiring group?

Does the taxing state permit corporations to file on a combined basis as of the date of acquisition (i e instant unity) or does it takeacquisition (i.e., instant unity), or does it take some amount of time for the corporations to become sufficiently integrated?

I th lt diff t f l f d Is the result different for newly formed corporations?

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MUCR Global Issues: InstantMUCR Global Issues: Instant Unity (Cont.)

California – Instant unity will generally not exist for a newly acquired corporation but will exist for a newly formed subsidiary.

Colorado – An affiliated group of includable corporations must file a combined report, but the report can only include those affiliated

b th t t t l t th f th imembers that meet at least three of the six statutory tests for unity during the tax year and the two preceding tax years. Thus, newly formed and newly acquired corporationsformed and newly acquired corporations may not join in the filing of a combined return.

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MUCR Global Issues: InstantMUCR Global Issues: Instant Unity (Cont.)

Texas – There is a presumption of unity for newly acquired and newly formed corporations.V t Wh ti i Vermont – When a corporation acquires another corporation, there is a presumption against a finding of a unitary relationship during g g y p gthe first reporting period. However, when a corporation forms another corporation, there is a presumption in favor of finding unitya presumption in favor of finding unity between the two corporations as of the date of formation.

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MUCR Global Issues:Joyce/Finnigan, Numerator

In Or OutIn Or Out Joyce rule states that where a unitary return

includes the net income of businesses that are taxpayers and businesses that are nottaxpayers and businesses that are not taxpayers of a state, receipts from the non-taxpayer businesses are not includable in the numerator of the receipts factor used to calculate tax due.

This principle is followed by the majority of This principle is followed by the majority of states utilizing combined returns.

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MUCR Global Issues: Joyce/Finnigan, Numerator

In Or Out (Cont.)In Or Out (Cont.) Finnigan approach states, “for purposes of

determining the numerator of the modified sales factor or any apportionment factor orsales factor or any apportionment factor or factors …”

A taxpayer is considered to be within the jurisdiction for income or franchise taxjurisdiction for income or franchise tax purposes of any state in which any member of its combined group is within the jurisdiction for income or franchise taxjurisdiction for income or franchise tax purposes.

A number of states are considering this type of t t t f t f t t bi dtreatment for out-of-state combined groups.

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MUCR Global Issues:MUCR Global Issues: Water’s Edge

Worldwide combined reporting – The combined report includes all members of the unitary business group regardless ofthe unitary business group regardless of the country in which the member is incorporated or the country in which the member conducts businessmember conducts business.

Water’s edge combined reporting – The combined report includes all members of th it b i t fthe unitary business group except for certain members that are incorporated in a foreign country and/or conduct most of h i b i id f h U Stheir business outside of the U.S.

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MUCR Global Issues:MUCR Global Issues: Water’s Edge (Cont.)

Criterion One: Whether the corporation is foreign or domestic

Criterion Two: Whether the corporation is an “80/20 corporation”an 80/20 corporation

Criterion Three: Sourcing of the ti ’ i ith f icorporation’s income as either foreign

source or U.S. source

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MUCR C it i OMUCR: Criterion One

Whether the corporation is foreign or domestic

Generally, based on where the corporation was i t d i dincorporated or organized

If an entity is organized in a foreign country and is recognized in that country as a corporation, but g y pthe entity’s owner elects to treat it as a branch or disregarded entity for U.S. purposes, then it is treated as a branch of its owner rather than a separate foreign corporationseparate foreign corporation.

A foreign corporation that is also an “80/20” corporation is considered domestic, if it elects to be included in a federal consolidated returnbe included in a federal consolidated return.

18

MUCR C it i TMUCR: Criterion Two

“80/20” status of corporation A corporation is considered an “80/20

ti ” if 80% f it ld idcorporation” if 80% or more of its worldwide gross income during its taxable year is “active foreign business income,” as defined in gsection 861(c)(1)(B) of the Internal Revenue Code.

A disregarded entity’s active foreign business income and worldwide income must be combined with those of its ownercombined with those of its owner.

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MUCR C it i ThMUCR: Criterion Three

Sourcing of the corporation’s income as either foreign source or U.S. source

Foreign source” vs. “U.S. source” is gdetermined by sections 861 – 865 of the Internal Revenue Code.

All income that is “effectively connected” with All income that is effectively connected with conducting a trade or business within the U.S. is considered U.S. source.

“Eff ti l t d i ” till b “ ti “Effectively connected income” can still be “active foreign business income” for purposes of the 80/20 test, to the extent not inconsistent with Internal Revenue Code.

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MUCR Addb k M difi tiMUCR: Addback Modifications

Required in cases where an expense subject to addback is included in combined unitary income but the corresponding income is or was notbut the corresponding income is or was not included in the group’s combined unitary income, such as:

An expense paid to a related entity that is not a combined group member

An expense paid to a combined group member that excluded the corresponding income from the combined items under the water’s edge rules

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MUCR: Expenses Subject ToMUCR: Expenses Subject To Addback

Interest expenses

Rent expenses

Intangible expenses

Management fees

22

MUCR Final Points:MUCR Final Points: The California Experience

It’s about the facts California’s long history Complexity of inter-company transactions Case law on what constitutes:

Diverse businesses Centralized management “Potential unity”

• Woolworth (U.S.)O id t l P t l (SBE)• Occidental Petroleum (SBE)

23

MUCR Final Points:MUCR Final Points:Constitutional Requirements

Commerce Clause requires fair apportionment Due Process requires taxing value within a Due Process requires taxing value within a

state’s borders “Some sharing or exchange of value not capable g g

of precise identification or measurement” “Flow of value,” not a flow of goods Functional integration, centralization of

management and economies of scale

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Combined Reporting S t I M h ttSystems In Massachusetts

Robert Carleo, Deloitte Tax [email protected]@deloitte.com

Overview

• Significant corporate excise tax changes that become effective for tax b i i ft J 1 2009 i l d th f ll iyears beginning on or after Jan. 1, 2009 include the following:

– Full conformity with federal entity classification rules

– Mandatory water’s edge combination for unitary businesses, including certain foreign entities (worldwide and affiliated group elections available)

– Complex apportionment rules applied to members of a combined groupComplex apportionment rules applied to members of a combined group

– A phased-in reduction in corporate excise tax rates (financial institutions and business corporations)

– Non-income tax imposed on entities with activities in MA with P.L. 86-272 protection. However, there should be no other major changes to the non-income measure.

Copyright © 2008 Deloitte Development LLC. All rights reserved.

26

Combined Group – Defined p• Taxpayers whose voting stock is more than 50% commonly owned by a

common parent (which may be foreign and does not need to be part of p ( y g pthe combined group) and engaged in a “unitary business” must file a pre-apportionment combined report. (Note that pre-2009 Massachusetts combined reports included only nexus members, and the combined group income was computed on a post-apportionment basis )group income was computed on a post-apportionment basis.)

• The water’s edge group includes the following members:– Domestic corporationsDomestic corporations

– Foreign corporations that have Massachusetts nexus

– Foreign corporations where the average of their property payroll and sales factorsForeign corporations where the average of their property, payroll and sales factors within the US is 20% or more

– Foreign corporations that earn more than 20% of their income from intangible property or service-related activities the cost of which is deductible for federal tax purposes by a


or service related activities, the cost of which is deductible for federal tax purposes by a member of the group (only to the extent of the intangible/service income)

27

Mandatory Water’s Edge Combinationy g• Entities now subject to combined reporting on a unitary basis

may include:may include:– Business corporations– Financial institutions

S ti– S corporations– Utility corporations– Real estate investment trusts (REITs)– Regulated investment companies (RICs)

• Entities NOT subject to combination:– Massachusetts security corporations– Insurance companies (except certain captive insurance

companies)


p )– Entities exempt from taxation under IRC § 501

28

Worldwide And Affiliated Group Electionsp• Water’s edge combination is the default group, but taxpayers

may make a 10-year election to file as either a worldwide unitarymay make a 10-year election to file as either a worldwide unitary combined group or a “ Massachusetts affiliated group.”

• A “Massachusetts affiliated group” is defined as a group of corporations whose voting stock is more than 50% commonly owned by a parent corporation. Affiliated group entities do not need to be engaged in a unitary business. All income of an g g yaffiliated group is treated as apportionable in a combined report.

• Affiliated groups also include foreign entities which have an g p gaverage of 20% U.S. apportionment or 20% income from inter-company intangible or service transactions.


• Any election must be made on a timely filed original return, including returns with a valid extension. 29

Conformity With The Federal CTB Rules

• Previously, Massachusetts did not conform to the federal check-the-box (“CTB”) regulations for eligible entities other than LLCs. In 2009, eligible( CTB ) regulations for eligible entities other than LLCs. In 2009, eligible entities that had been treated differently in Massachusetts than they were for federal purposes (i.e., hybrid entities) no longer received this disparate treatment.

• Entities affected by this amendment include:

– Massachusetts corporate trusts (“MBT”) – No longer subject to individual p ( ) g jtax rate (5.3%) but rather to the rate applicable to the federal entity classification. Now subject to non-income measure tax (i.e., net worth or MA tangible property).

– Partnerships (LR 99-13 partnerships) – No longer treated as flow-through entities if they elect to be taxed as corporations for federal income tax purposes.


– Qualified subchapter S subsidiary (“Qsub”) – No longer subject to income and non-income measure taxes on a separate entity basis. 30

Other Considerations

Taxpayers have many opportunities in the area of group composition to create the most tax efficient filing group especiallycomposition to create the most tax efficient filing group, especially the following entity types: Foreign-owned corporations Entities with non-unitary business lines related by common

outside ownership Entities with significant foreign activityg g y

Conversely, the Massachusetts rules present issues that taxpayers should consider such as:

Incl sion of foreign entities recei ing interest ro alties or Inclusion of foreign entities receiving interest, royalties, or service income from related U.S. entities Unity determinations, especially where the unitary group may


differ from other states due to the definition of the water’s edge group 31

Combined Group’s Taxable Incomep• The unitary combined group computes taxable income on a pre-

apportionment basis Losses reported by one member may beapportionment basis. Losses reported by one member may be used to offset the profits generated by another member.

• Income from inter-company transactions between combined b th t l t t th ’ it b i ldgroup members that relates to the group’s unitary business would

generally be deferred in accordance with the federal consolidated return regulations. However, the income may be recognized

li th f f d l t if th t titearlier than for federal tax purposes, if the property or entity involved in the transaction leaves the unitary business.

• The tax rate for business C corporations will decrease as follows: p8.75% in 2010, 8.25% in 2011 and 8% in 2012 and beyond. (Note that there are also rate decreases for financial institutions and S corporations.)


p )

32

Dividends

• Dividend income paid by one group member to another will be eliminated to the extent it is paid out of the E&P of the

it b i ( t i l di 2009 E&P hi h iunitary business (not including pre-2009 E&P which is considered non-unitary).The 95% dividends-received deduction will generally be allowed for inter-company di id d th t t id t f it E&Pdividends that are not paid out of unitary E&P.


33

Capital And §1231 Gains/Lossesp §• Gains/losses of members resulting from the sale of unitary assets is first

segregated between capital gain/loss (§ 1221 assets) and § 1231 gain/loss.g g p g (§ ) § g• Each member’s segregated gains/losses are then netted to determine if the

member has a net capital or § 1231 gain/loss.• The net gains/losses are then aggregated.• The aggregated net gains/losses are then apportioned to each nexus member of

the group. (Note that gains/losses from sales of non-unitary assets are allocated entirely to the group member that generated them.)Aft ll ti ti t th b ’ tt ib t bl i /l• After allocation or apportionment, the nexus member’s attributable gains/losses are added to its share of the combined group apportioned ordinary income subject to tax.

• A nexus member’s apportioned share of net capital gain is included while a netA nexus member s apportioned share of net capital gain is included, while a net capital loss may not be deducted by the nexus member and cannot be carried over to future tax years.

• A nexus member’s apportioned share of net § 1231 gain/loss is included by the


nexus member, and an excess § 1231 loss can be carried over to future tax years.

.34


The rules in the area of dividends and capital gains are extremely complicatedcomplicated.

Taxpayers with significant dividends and/or capital gains/losses must evaluate in which group entity such dividends or gains/losses are generated. Included in this analysis should be:

Potential exclusion of non-unitary dividends or capital gains

Maximizing group use of capital losses


35

Combined Apportionmentpp• A unitary group computes a combined taxable income subject to

apportionment. However, combined taxable income is pp ,apportioned to Massachusetts only through the “taxable” (i.e., nexus) member(s). Each taxable member must compute its own apportionment factor made up of its separate company numerator(s) divided by the combined group’s denominator(s).

• In accordance with the regulation, transactions between combined group members related to the unitary business will g p ygenerally be eliminated in determining the apportionment factors of the combined group’s taxable members.

• Apportionment for purposes of the non-income measure of theApportionment for purposes of the non income measure of the corporate excise tax is unaffected by the new combined reporting rules and will be determined on a separate-company basis.


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Manufacturing/Sales Company Structuresg y

• Where one group member manufactures a product that g p pis ultimately sold by another group member, the activities of the two entities will be combined to d t i h th th di t ib ti tit ill b t t ddetermine whether the distributing entity will be treated as a manufacturer for MA tax purposes. If the combined manufacturing activity is substantial, both members will g y ,be required to use a single sales factor.

• Sales companies that are classified as manufacturers under this rule cannot generate investment tax credits (ITCs) but may share in ITCs generated by manufacturer group members


manufacturer group members.37

Combined Apportionment – Special Rulespp p

• Finnigan approach– No throwback will be required of any sales to a state where any– No throwback will be required of any sales to a state where any

group member has nexus, but Massachusetts destination sales from non-nexus members will be included in the sales factors numerators of the taxable members of the group on a pro rata basis.of the taxable members of the group on a pro rata basis.

Financial institutionsIn situations where financial institutions and general business– In situations where financial institutions and general business corporations are included in the same combined group, the following adjustments must be applied:

• Intangible property included in the property factor of a financial• Intangible property included in the property factor of a financial institution member is reduced to 20% of the otherwise determined amount.

• Receipts otherwise excluded from the sales factor of members


• Receipts otherwise excluded from the sales factor of members that are not financial institutions are added thereto (e.g., interest, dividends).

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Net Operating Losses (NOLs)p g ( )• Post-combination losses

– May be shared after application to the income of the generating entityMay be shared after application to the income of the generating entity with corporations which were part of the combined group in the year of the loss. This would not apply to financial institutions or utilities which are not eligible to use or generate NOLs under MA law.

• Pre combination losses• Pre-combination losses– May only be utilized on a post-apportioned, separate-company basis

by the generating entity. The amount of income against which such loss may be applied is limited as follows:loss may be applied is limited as follows:

Group’s combined income x loss entity’s numerators from year of lossgroup’s denominators in the year used

– Taxpayers may elect to increase the numerator of the limitation aboveTaxpayers may elect to increase the numerator of the limitation above by the average of the increase of the group’s property and payroll in Massachusetts from the loss year to the year the loss is used.

• Changes in ownership/mergers


• Changes in ownership/mergers– NOL carryforwards of liquidated/merged members will be lost. 39

Credits• Post–combination credits

– May be shared if the credit can be validly claimed by a taxable member and attributable to the group’s unitary business. For example, ITC may only be shared with manufacturing corporation or R&D corporation group members, while R&D credits may be shared with all members. (Note that the credit must first be applied to the excise of the generating member )first be applied to the excise of the generating member.)

• Pre-combination credits– May be shared with a member of the taxpayer’s current unitary combined

group that may validly claim the credit and that was either a member of the g p y ytaxpayer’s combined group during the FY 2008 tax year or its successor in interest under continuity of ownership

• Changes in ownership/mergers– Upon leaving a combined group, a taxpayer’s credit carryforward will no

longer be available for use by the group. For ITC, recapture provisions are applicable.C f d f b th t li id t d d l t


– Carryforwards of members that are liquidated or merged are lost.

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Taxpayers should re-examine all material Massachusetts deferred tax assets (DTAs) to determine the limitation on their use undertax assets (DTAs) to determine the limitation on their use under combined reporting and revisit historical valuation allowances.

For example, due to the NOL carryforward limitations, entities may not be able to use more than a small amount of their pre-combination NOL carryforwards.

Conversely, if a manufacturing corporation will now be able to share ITC (for which the associated DTA has a valuationshare ITC (for which the associated DTA has a valuation allowance), it may be able to take all or a part of that valuation allowance down.


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Critical Takeaways

Composition of the group Any worldwide or affiliated election must be made on a properly Any worldwide or affiliated election must be made on a properly

extended first return Was there an adequate extension payment made?

Foreign entity inclusion Foreign entity inclusion Are all 20% inter-company service companies included? Are there any foreign

entities which may have Massachusetts nexus in light of Geoffrey?

Income subject to apportionmentIncome subject to apportionment Capital gains and loss rules

Can you offset gains and losses after segregation? Are the gains unitary or non-unitary in nature?y

Dividends Is the dividend paid entirely from unitary E&P if being eliminated?


42

Critical Takeaways (Cont.)

Apportionment Only taxable members of the group apportion group income Only taxable members of the group apportion group income Finnigan

Is the nexus footprint of all members being taken into account for throwback purposes? Are the Massachusetts sales of non-nexus members being allocated topurposes? Are the Massachusetts sales of non-nexus members being allocated to nexus members?

Financial institutions Does the group have FIs and non-FIs? If so, are the proper adjustments to the g p , p p j

property and sales factors being made?

Net operating losses Limitation on pre-combination lossesp

What amount of NOL can be carried for financial statement purposes? Is the limitation being computed using the correct weighted average? Is the limitation being computed without regard to throwback?


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This presentation contains general information only and is based on the experiences and research of Deloitte practitioners. Deloitte is not, by means of this p p ypresentation, rendering business, financial, investment, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business Before making any decision or taking any action thatmay affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte, its affiliates, and related entities shall not be responsible for any loss sustained by any person who relies on this presentation.


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Wisconsin’s Combined R ti S tReporting System

Howard Wagner, Crowe [email protected] @

Wisconsin

• Combined reporting effective for tax years beginning on or after Jan. 1, 2009 for corporations engaged in a unitary business

• 50% ownership test applies for combined reporting

• Regulations 2.60 through 2.67 were issued on an emergency basis effective from Aug. 5, 2009 through Jan. 5, 2010. Final regulations were issued on Jan. 15, 2010.

• Combined returns must be filed electronically.

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Wisconsin (Cont.)

• The federal regulations listed below are specifically referenced or adopted in the regulations, but modified to apply to Wisconsin combined groups instead of federal consolidated groups.

• 1502-13, relating to inter-company transactions.• 1502-22 and 1502-23, relating to capital gains and losses and Sect.

1231 i d l1231 gains and losses • 1502-24, relating to charitable contributions (s. Tax 2.61(6)(d)).• 1502-32, relating to investment (stock basis) adjustments • 1502-33, relating to earnings and profits

47

Wisconsin (Cont.)

• A passive parent holding company that directly or indirectly controls one or more operating company subsidiaries engaged in a unitary business is deemed to be engaged in a unitary business with thebusiness is deemed to be engaged in a unitary business with the subsidiary or subsidiaries, even if the holding company’s activities are primarily passive.

• Any business conducted by a pass-through entity that is owned directly or indirectly by a corporation is treated as conducted by the corporation, to the extent of the corporation’s ownership of the pass-through entity.

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Wisconsin (Cont.)

• A foreign corporation with at least 80% of its income earned outside of the U.S. is excluded from the combined group.

• A foreign corporation that does not earn at least 80% of its income outside of the U.S. only includes its U.S. source income and related

i i h bi dapportionment in the combined report.

• If a corporation’s income is not taxable for federal income tax d th i i f f d l t t th i i tpurposes under the provisions of a federal treaty, the income is not

taxable for Wisconsin purposes and is not required to be included in combined unitary income.

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Wisconsin (Cont.)

• A domestic corporation with at least 80% of its income earned outside of the U.S. is a consolidated foreign operating corporation.

• A consolidated foreign operating corporation includes in the unitary combination only its net income or loss, and the related apportionment factors, from the unitary business that is U.S. source income in thefactors, from the unitary business that is U.S. source income in the unitary return.

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Wisconsin (Cont.)

• Finnigan rule applies for throwback.

• Industries with special apportionment rules, such as telecom i d t i i l d d i th bi d tcompanies and motor carriers, are included in the combined return

with entities that do not use special apportionment factors.

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Wisconsin (Cont.)• A combined group member may share its net business loss• A combined group member may share its net business loss

carryforward with other combined group members to the extent that all of the following conditions are met:

The net business loss originated in a taxable year beginning on or– The net business loss originated in a taxable year beginning on or after Jan. 1, 2009 and is attributable to combined unitary income included in a combined report.The member originally computed the net business loss in the– The member originally computed the net business loss in the combined report for the same combined group as the combined group that will use the shared loss carryforward, regardless of whether corporations have joined or left the combined group in thewhether corporations have joined or left the combined group in the intervening years.

– The member is still a member of the combined group for the year the loss carryforward will be shared.the loss carryforward will be shared.

52

Wisconsin (Cont.)

• A SRLY rule applies to net losses incurred in tax years beginning before Jan. 1, 2009 that are carried forward into the unitary return.

• Loss carryforwards from unitary return years can be shared by the group.

• If a member leaves the group, that member’s share of unused loss may be used by that member but cannot be shared with any other combined groupsgroups.

53

Wisconsin (Cont.)

• A corporation filing in a combined report may offset its tax (including tax attributable to its share of the combined group’s income) withtax attributable to its share of the combined group s income) with credits such as the research credits, development zone credits, etc.

• These credits and any credit carryforwards are available only to the• These credits and any credit carryforwards are available only to the separate corporation that generated them.

54

Wisconsin (Cont.)

• Each combined group has a sole designated agent, which acts on behalf of the entire combined group.behalf of the entire combined group.

Th d i t d t i th t ti (if t• The designated agent is the parent corporation or (if no parent corporation) may be appointed by the members.

55

Combined Reporting In C lif i A d Illi iCalifornia And Illinois

Howard Wagner, Crowe [email protected]@crowehorwath.com

California And Illinois

• Illinois adopts a water’s edge approach to combined returns, and excludes 80/20 companies from the unitary group.excludes 80/20 companies from the unitary group.

C lif i d t ld id bi ti A t ’ d l ti i• California adopts a worldwide combination. A water’s edge election is available.

57

California

• For tax years beginning on or after Jan. 1, 2011, California unitary returns will return to the Finnigan throwback rule and eliminate the use of the Joyce rule.

• Under the Finnigan rule, items shipped from California will not be included in the numerator of the California sales factor if any member of the unitary group has nexus in the state to which the goods are shipped.

• In addition, all sales to California by members of a unitary group will be included in the numerator of the California sales factor, even if the member selling the goods does not have California nexus.

Member Crowe Horwath International © 2009 Crowe Horwath LLP58

California (Cont.)

• The computation of the California apportionment factor will adopt the market benefit rule for sales other than sales of tangible personal property for tax years beginning on or after Jan. 1, 2011.

• Under the market benefit rule, a sale will be included in the numerator of the California sales factor if the purchaser receives the benefit of the transaction in California.

• The current California apportionment formula is a three factor formula that• The current California apportionment formula is a three-factor formula that uses a double-weighted sales factor, a property factor and a payroll factor.

• For tax years beginning on or after Jan. 1, 2011, taxpayers will have the ability to make an annual election to apportion using only the sales factor. pp g y

• This election is not available for taxpayers engaged in an agricultural business activity, an extractive business activity, a savings and loan activity or a banking or financial business activity.


California (Cont.)

• NOL deductions are disallowed for the 2008 and 2009 tax years, except for taxpayers with net business incomes of less than $500,000 in either year.

• NOLs incurred on or after Jan. 1, 2008 may be carried forward up to 20 years, and NOLs incurred on or after Jan. 1, 2011, may be carried back up to two years. The carryback provisions will be gradually phased in as follows: – 50% of 2011 NOLs may be carried back

75% f 2012 NOL b i d b k– 75% of 2012 NOLs may be carried back– The full amount of NOLs attributable to a taxable year beginning on or

after Jan. 1, 2013 may be carried back• The LLC fee must be paid by June 15 of the current taxable year rather than• The LLC fee must be paid by June 15 of the current taxable year rather than

April 15 of the following year, beginning with the 2009 tax year.


California (Cont.)

• California’s Commission on the 21st Century Economy was created by Gov. Schwarzenegger to study reforms to the California tax system.

• The following is a summary of the commission’s key business tax recommendations:– Eliminate the corporation tax and the franchise minimum tax– Eliminate the corporation tax and the franchise minimum tax– Eliminate the state general purpose sales tax– Establish the business net receipts tax (BNRT)– Create an independent tax dispute forum

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California (Cont.)

• The BNRT recommended by the commission appears to be modeled after Michigan’s modified gross receipts tax.

• In general terms, the formula for the BNRT is:

G R i t P h f Oth Fi N t R i t• Gross Receipts - Purchases from Other Firms = Net Receipts

• Net Receipts * BNRT Rate = BNRT Liability

• The commission indicated that a 4% BNRT rate would achieve revenue neutrality once the tax has been fully phased in.

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Illinois

• Administrative Hearing Decision No. IT 09-9, Illinois Department of Revenue, Aug. 24, 2009.

• The taxpayer historically filed one unitary return for its entire group. • The taxpayer had two separate and distinct lines of business.• Taxpayer filed amended returns reflecting each line of business as a separate

unitary group.• Taxpayer contended that the two groups of companies could not be combined,

because the business activities conducted by them are separate and unrelated.• The department audited the amended returns and denied the refund claims,

concluding that the two groups of companies were related through the exerciseconcluding that the two groups of companies were related through the exercise of strong centralized management by their common parent.

• The administrative law judge held for the Revenue Department and denied the refund claims.

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Illinois (Cont.)

• 86 Ill. Admin. Code § 100.2430• The regulation was amended to conform to prior law changes

regarding the disallowance of corporate income tax deductions for certain expenses paid to related parties who would be unitary with the taxpayer if not for the fact that they act primarily outside the U.S.

• The regulation was also amended to conform to prior legislative changes that expanded the disallowance provisions to also apply to expenses, including insurance premiums, paid to related parties who would be unitary with the taxpayer but for the prohibition against i l di fi i l i ti i i dincluding financial organizations, insurance companies, and transportation companies in unitary groups with taxpayers engaged in other businesses.

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Combined Reporting In Mi hiMichigan


Michigan

• All entities and persons subject to tax are includible in the unitary group

• Partnerships and S corporations are taxable entities for the MBT.Partnerships and S corporations are taxable entities for the MBT. Accordingly, the unitary group includes these entities if they meet the ownership test and relationship test.

• The return includes only U.S. persons and is done on a water’s edgeThe return includes only U.S. persons and is done on a water s edge basis.

• Foreign operating entities are excluded from the unitary group.• A foreign operating entity is a U S person who would otherwise be• A foreign operating entity is a U.S. person who would otherwise be

part of unitary group that earns at least 80% of its income as active foreign income under 861(c)(1)(B).

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Michigan (Cont.)

• Two requirements must be met for unitary combination:

Control test: One of which owns or controls directly or indirectly– Control test: One of which owns or controls, directly or indirectly, more than 50% of the ownership interest with voting rights or interests with comparable rights; and

– Relationship test: Business activities result in a flow of value or– Relationship test: Business activities result in a flow of value or between or among the persons in the unitary business group or that has business activities or operations that are integrated with, are dependent upon or contribute to each other.depe de upo o co bu e o eac o e .

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Michigan (Cont.)

• All inter-company transactions are eliminated from the modified gross receipts tax base, the business income tax base and the apportionmentreceipts tax base, the business income tax base and the apportionment formula.

• Banks subject to net capital tax and insurance companies subject to• Banks subject to net capital tax and insurance companies subject to gross premiums tax are excluded.

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Michigan (Cont.)

• Revenue Administrative Bulletin 2010-1 outlines the control test.• A person owns or controls more than 50% of the ownership interests

with voting rights or ownership interests that confer comparable rightswith voting rights or ownership interests that confer comparable rights to voting rights of another person if that person owns or controls, directly or indirectly:– More than 50% of the total combined voting power of allMore than 50% of the total combined voting power of all

ownership interests with voting (or comparable) rights, or– More than 50% of the total value of all ownership interests with

voting (or comparable) rightsvo g (o co pa ab e) g s• Can be parent sub or brother/sister controlled groups• Principles of IRC 318 apply for attribution

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Michigan (Cont.)

• Revenue Administrative Bulletin 2010-1 outlines the relationship test.• The relationship test is satisfied when the group of persons have

business activities or operations that either:business activities or operations that either:– Result in a flow of value between or among persons in the group,

or– Are integrated with dependent upon or contribute to each other– Are integrated with, dependent upon, or contribute to each other

• A taxpayer need only meet one of the two alternative tests to satisfy the relationship test.A li t diti l it t t (f ti l i t ti t li d• Applies traditional unitary tests (functional integration, centralized management, economies of scale)

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C bi d R ti ICombined Reporting In Texas, New York, Ohio , ,

And West Virginia

Mary Bernard Kahn Litwin Renza and CoMary Bernard, Kahn Litwin Renza and [email protected] Neff, RSM McGladrey, y

[email protected] Carleo, Deloitte Tax LLP

[email protected]

Texas Margin Tax

• Franchise margin tax effective for reports due on or after Jan. 1, 2008

• Mandatory combined reporting

• Calculation of margin1. 70% of total revenue2. 70% of gross revenue less cost of goods sold3. 70% of gross revenue less compensation

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Texas Margin Tax (Cont.)

• Includible entities• Includible entities– Corporations, partnerships, LLCs, LLPs, business trusts, joint

ventures, holding companies and other legal entities

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Texas Margin Tax (Cont.)g ( )

Definition: Combined group• “Affiliated group” engaged in unitary businessg p g g y• Affiliated group

– Controlling interest (direct or indirect)Corporation– Corporation

• Either more than 50% of voting power of all classes of stock, or more than 50% of beneficial ownership interest in voting stockstock

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• Affiliated group (Cont.)Partnership– Partnership

• More than 50% of capital, profits or beneficial interest in partnership

LLC– LLC• More than 50% of total membership interest or beneficial

ownership interest in the membership interest of LLC

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Texas Margin Tax (Cont.)Texas Margin Tax (Cont.)

Definition – Unitary business

• Single economic enterprise of separate parts of a single entity or commonly controlled group of entities sufficiently interdependent, integrated, or interrelated through activities to provide synergy or

t l b fit th t d h i h f lmutual benefit that produces a sharing or exchange of value among them and a significant flow of value to separate parts

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Definition Unitary business (Cont )Definition – Unitary business (Cont.)• Relevant factors

– Group members in same general line of business– Steps in a vertically structured enterprise or process– Functionally integrated through strong centralized management

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Texas Margin Tax (Cont.)g ( )

Combined apportionment

• Single sales factorSingle sales factor• No throwback• Joyce for calculation, Finnigan for reporting

N d d• Nexus standard – Franchise tax; P.L. 86-272 is not applicable– For example, soliciting, acting as general partner, providing

services through independent contractors generate nexus

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• Additional clarificationReporting requirements of non taxable entities– Reporting requirements of non-taxable entities

– EZ computation limitations– Public information report/ownership information report– Limitation on 100% extension option– Electronic funds transfer requirements– Compensation = Medicare wages and tips

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• Additional clarification• Additional clarification– Controlling interest example– Combined group member with no nexus– Combined group members with different accounting periods– Members joining or leaving the combined group

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Combined Reporting In New York

• Effective for tax years beginning on or after Jan. 1, 2007, a taxpayer is required to include in its combined report any company that is substantially, i.e., 80% or more, owned

d i h hi h i h b i l iand with which it has substantial intercorporate transactions, regardless of whether those transactions were entered into at arm’s length pricesU d th d d t t t t f i i i i l t• Under the amended statute, transfer pricing is irrelevant as long as there are substantial intercorporate transactions

• In situations where substantial intercorporate transactions do not exist taxpayers or the Audit Division will still bedo not exist, taxpayers or the Audit Division will still be able to argue that combination is required to cure distortion arising from the inter-company relationships

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Combined Reporting In New YorkCombined Reporting In New York (Cont.)

• In determining whether “substantial intercorporate transactions” exist, the commissioner will consider and evaluate all activities and transactions of the taxpayer and related corporations including, but not limited to: (i) manufacturing, acquiring goods/property, or performinglimited to: (i) manufacturing, acquiring goods/property, or performing services for related corporations; (ii) selling goods acquired from related corporations; (iii) financing sales of related corporations; (iv) performing related customer services using common facilities and employees for related corporations; (v) incurring expenses that benefit,employees for related corporations; (v) incurring expenses that benefit, directly or indirectly, one or more related corporations; and (vi) transferring assets, including such assets as accounts receivable, patents or trademarks, from one or more related corporations

• TSB-M-08(2)C (Taxation and Finance Department March 3 2008)• TSB-M-08(2)C (Taxation and Finance Department, March 3, 2008). This Technical Services Bureau Memorandum sets forth the division’s current interpretation of the amended statute

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• Bausch & Lomb, Inc., DTA No. 819883 (N.Y.S. Tax App. Trib. Dec. 20, 2007). The New York State Tax Appeals Tribunal held that a lossState Tax Appeals Tribunal held that a loss resulting from the sale of a subsidiary that had been included in the taxpayer’s New York p ycombined report was not attributable to subsidiary capital and was not required to be excluded in determining entire net income It was available todetermining entire net income. It was available to be carried back and used as an offset against the taxpayer’s entire net income

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• TSB-M-08(3)C (Taxation and Finance Department, March 10, 2008). The Department states that, effective for all open years, gains resulting from the sale of a subsidiary that had been included in the taxpayer’s New York combined report are: (1) included in the computation ofNew York combined report are: (1) included in the computation of entire net income; (2) business income; and (3) allocable (apportionable) by the combined group’s business allocation percentage (although the gain is not included in the receipts fraction). The parent corporation may deduct expenses that are attributable to theThe parent corporation may deduct expenses that are attributable to the stock of an included subsidiary. The stock of the included subsidiary is not included in combined business capital and investment capital or combined subsidiary capital for the period the subsidiary is included in the combined reporte co b ed epo

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• New York City similarly amended its combined reporting requirements. p g qHowever, such changes are effective for tax years beginning on or after Jan. 1, 2009y g g ,

• Thus, for the 2007 and 2008 years, the combined reporting requirements for Newcombined reporting requirements for New York State and New York City are different

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Ohio CAT

C i l i i l d f hi• Commercial activity tax replaced franchise tax

• Annual privilege tax measured by gross receipts on business activities in Ohio

• Applies to all types of businesses and all types of entitiespp yp yp

• Nexus standardOwns or uses capital or property in the state– Owns or uses capital or property in the state

– Authorized to do business in the state– Has bright line presence in the state

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Ohio CAT (Cont.)

• “Bright line presence”Has property in state with value of $50 000 or more;– Has property in state with value of $50,000 or more;

– Has payroll in state of $50,000 or more;– Has taxable gross receipts in state of $500,000 or more;– Has 25% or more of its total payroll, property or gross receipts

within the state; OR– Is domiciled in the state.

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Ohio CAT (Cont.)

• Group options• Group options

– Consolidated election– Combined group

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Ohio CAT (Cont.)

Consolidated electionConsolidated election• Include all entities with either 50% or 80% common ownership • Intercompany receipts not taxable• Election binding for eight quarters• All common owned entities included, even without nexus• May elect to include all foreign corporations with same ownership

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Ohio CAT (Cont.)

Combined taxpayer groupCombined taxpayer group

• Without consolidated election, taxpayers with common ownership of 50% t fil bi d50% or more must file as combined group

• May not exclude intercompany receipts• Only include entities with nexus

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Ohio CAT (Cont.)

• Additional clarificationsGross receipts includes insurance proceeds for loss of business– Gross receipts includes insurance proceeds for loss of business revenue

– Gross receipts excludes cash discounts, returns and allowances, and bad debtsand bad debts

– Reporting person – designated by the group to legally bind the group for all tax filings and liabilities

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Ohio CAT (Cont.)

• Consolidated elected taxpayers (effective 10 16 09)• Consolidated elected taxpayers (effective 10-16-09)

– Reporting member liable – not all jointly and severally liable– Process to change elections simplified

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West Virginia

• Mandatory combined reporting effective for tax years beginning on or• Mandatory combined reporting, effective for tax years beginning on or after Jan. 1, 2009 for unitary group

Fi t t t t f ll M lti t t T C i i d l t t t• First state to follow Multistate Tax Commission model statute

• All members with nexus must apportion income

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West Virginia (Cont.)

• Separate returns filed but income based on unitary group income or• Separate returns filed, but income based on unitary group income or elect to file group tax return

W t ’ d d f lt l ti• Water’s edge default election

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Nexus standards

• “Doing business in West Virginia if any activity of the corporation enjoys the benefits and protection of the government or laws of West Virginia”Virginia

• Significant economic presence test (MBNA)

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Taxable entities

– Corporations

– Partnerships

– Only insurance companies are not subject to corporate income tax

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Apportionment

• Three-factor apportionment – double-weighted sales

• Joyce rule, effective 1/1/09

• No throwback

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Unitary business

1. Controlled group, commonly owned in same general line of business

2. Vertical integration – steps in a structured enterprises, e.g. extraction of minerals

3. Functional integration

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• Additional definitions

– Intangible property – patents, patent applications, trade names, trademarks, service marks, copyrights, mask works and trade secretssecrets

– Intangible expense – directly or indirectly related under IRC Sect. 163 f t163, fees, etc.

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W Vi i i (C )West Virginia (Cont.)

• Additional definitions– Ownership – constructive ownership under IRC Sect. 318(a)

R l t d tit “f il ” d IRC S t 318 t l t 50%– Related entity – “family” under IRC Sect. 318 owns at least 50% of the value of the stock

– Related member – component member under IRC Sect. 1563– Valid business purpose – primary motivation for business activity

that changes the taxpayer’s economic position in a meaningful way, other than for avoidance or reduction in tax

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Future Outlook


mandatory combined reporting for state income...

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