New York's combined return possibilities. (State & Local Taxation)by Genetelli, Richard
Combined reporting can produce significant tax savings for a number of reasons. For example, it permits the losses of unprofitable companies to offset the income of profitable affiliates. Combined reporting may also result in a tax benefit for multi-state companies as a result of the impact of such filing method on the apportionment factors. In addition, combination eliminates the tax on subsidiary capital in New York.
New York State and City require that a written request for permission to file on a combined basis must be received by the State and City within 30 days after the close of a taxpayer's year end. Therefore, January 30, 1993, is the deadline for calendar-year taxpayers to request permission to file a combined report. It should be noted that although the State and City have similar rules for combined reporting, separate requests for permission must be submitted.
General corporations must meet the following three requirements to file a combined report in New York:
1. Capital Stock Requirement. Eighty percent or more of the voting stock of the corporations in the combined group must be owned or controlled, either directly or indirectly, by a member of the group or by the same interests;
2. Unitary Business Requirement. The corporations to be included in the combined report must be engaged in related activities or the same or related lines of business; and
3. Distortion Requirement. Filing on a separate basis would result in a distortion of the corporation's activities, business, income, or capital in New York. The distortion requirement is presumed to be met if at least 50% of a corporation's receipts or expenses are derived from qualified activities with group members ("substantial intercorporate transactions").
The State and City require substantial information detailing that the three requirements are met. However, if such information is not available as of the combined report request deadline, it may be possible to submit a simplified request at that time. The State and City will generally consider such a request as timely filed, with the detailed information to be provided at a later date.
Retroactive Combination. The enforceability of the 30-day rule has been the subject of much litigation over the past few years. The holdings in Petition of Autotote Limited, Tax Appeals Tribunal, April 12, 1990, and Petition of Chudy Paner Co., Inc., Tax Appeals Tribunal, April 19, 1990, make it clear that the Division of Taxation cannot use the 30-day rule to prohibit a taxpayer under audit from filing on a combined basis retroactively if all requirements for combination are met. New York City has issued a statement of audit procedure to the same effect (Department of Finance Audit Division, Statement of Audit Procedure, AP/GCT-3).
More recently, the Department of Taxation entered into a stipulation with a taxpayer to waive the 30-day rule with respect to a request to file on a combined basis if the taxpayer could establish the existence of distortion on a separate reporting basis. In Petition of A.G. Becker Paribas Group Inc., Administrative Law Judge Unit, February 20, 1992, a Delaware parent corporation timely filed franchise tax reports on a combined basis with related corporations including a wholly owned Delaware subsidiary. The Department conducted a field audit and decombined the wholly owned subsidiary because no timely request was made to include the subsidiary in the combined report.
The parties entered into a stipulation whereby if the taxpayer could establish that filing on a separate basis resulted in distortion, the Department would acknowledge that all elements were present to support a combined filing. Furthermore, as part of the stipulation, the Department would not preclude combination because of the taxpayer's failure to timely request permission to include the wholly owned subsidiary in the combined report.
The taxpayer moved for a summary determination that a combined report was warranted because the facts clearly supported a showing of distortion. The Administrative Law Judge determined that the distortion issue involved mixed questions of law and fact appropriate for a trial, and denied the motion for summary determination. Nevertheless, the case is one of first impression in that the State removed the 30-day rule as an obstacle to permitting a combined filing. It should be noted that Administrative Law Judge Unit determinations have no precedential value in the Division of Tax Appeals or any New York State judicial proceeding.
In view of the holdings in Autotote Limited, Chudy Paner and Becker Paribas Group, taxpayers should review the implications of combination not only for the current and future years, but also for all prior open years.
Forced Combination. On February 6th, the Tax Appeals Tribunal, in Petition of Standard Manufacturing Co. Inc., redefined the law in New York with respect to the involuntary combination of a non-New York taxpayer at a time when the State's authority to require such a filing was the subject of controversy and confusion. The Tax Appeals Tribunal held that an opportunity to rebut the presumption of distortion must be provided where New York seeks to compel a combined report between a non- New York taxpayer and a New York taxpayer, and substantial intercorporate transactions exist. A line of New York Court of Appeals cases had previously deemed the distortion requirement to be irrelevant where New York attempted to compel combination between a non-New York taxpayer and a New York taxpayer based on stock ownership, unitary operations and substantial intercorporate transactions (see Matter of Campbell Sales Co. v. State Tax Commission, 68 N.Y. 2d 617, June 3, 1986, and Matter of Wurlitzer Co. v. State Tax Commission, 35 N.Y. 2d 100, July 11, 1974). Since Standard Manufacturing reported intercompany transactions based on adjustments related to a IRC Sec. 482 audit conducted by the IRS, the presumption of distortion was rebutted, and a combined report was not required.
The rationale of Standard Manufacturing was followed four months later in Petition of Campbell Sales Company, Administrative Law Judge Unit, June 11, 1992. In Campbell Sales, New York again sought to compel a combined report between a non-New York taxpayer and a New York taxpayer on the grounds of stock ownership, unitary operations, and substantial intercorporate transactions. As in Standard Manufacturing, Campbell Sales was given an opportunity to rebut the presumption of distortion. Therefore, Campbell Sales was able to establish through expert testimony that filing on a separate basis properly reflected its tax liability in New York and a combined report was not required. Significantly, although an IRC Sec. 482 adjustment was not present in Campbell Sales, the Administrative Law Judge looked to the principles inherent in IRC Sec. 482 for guidance. The Administrative Law Judge noted that such principles were consistent with the goal of avoiding distortion by implementing arm's length standards between related parties.
More recently, in Petition of USV Pharmaceutical Corporation, Tax Appeals Tribunal, July 16, 1992, New York attempted to impose forced combination with a non-New York taxpayer on facts similar to those in Standard Manufacturing. The Tax Appeals Tribunal applied its analysis in the Standard Manufacturing decision and afforded USV Pharmaceutical an opportunity to rebut the presumption of distortion. USV Pharmaceutical did so by showing that its substantial intercompany transactions were reported based on IRC Sec. 482 adjustments. The Tax Appeals Tribunal concluded that IRC Sec. 482 and New York Tax Law Sec. 211.4 share the common purpose of properly reflecting income, and that IRC Sec. 482 adjustments rebut the presumption of distortion that arises from a unitary relationship and substantial intercorporate transactions.
In view of the holdings in Standard Manufacturing, Campbell Sales, and USV Pharmaceutical, taxpayers should review the potential exposure associated with required combination in New York. Specifically, taxpayers should review the pricing of intercompany transactions to determine whether arm's length pricing can be established to rebut the presumption of distortion stemming from substantial intercorporate transactions. In addition, taxpayers should consider whether the above holdings provide a basis to invalidate any previous combined filings.
Other Related Issues
Another significant issue in New York that should be considered in conjunction with the filing of a combined report involves the disallowance of expenses attributable to subsidiary capital. By way of background, the Tax Reform and Rate Reduction Act of 1987 requires taxpayers in New York State to characterize all deductions as either directly or indirectly attributable to subsidiary, investment, or business capital for post-1986 tax years. Deduction which are directly attributable to subsidiary capital must be added back to Federal taxable income in computing entire net income. Deductions which are indirectly attributable to subsidiary capital are determined by a formula, and must also be added back to Federal taxable income. This procedure is also followed by New York City for post-1987 tax years. The overall purpose of the expense attribution adjustment is to prevent a parent corporation from obtaining a double benefit since New York generally allows such corporation to exclude income from subsidiary capital in the computation of its entire net income.
New York has recently become quite aggressive with respect to the attribution of expenses to subsidiary capital. As a result, many taxpayers are receiving large and unexpected assessments based on this expense attribution adjustment.
In addition, two recent decisions have magnified the significance of a potential expense attribution adjustment. In Matter of The Unimax Corporation v. Tax Appeals Tribunal, 79 N.Y. 2d 139, February 18, 1992, the Court of Appeals upheld audit guidelines of the Department of Taxation and Finance that permit loans and advances to a subsidiary to be offset only by loans and advance from that same subsidiary in determining a taxpayer's investment in subsidiaries. The Unimax holding may affect the numerator of the indirect attribution formula by preventing taxpayers from treating all loans and advances from subsidiaries as offsets against loans and advances to subsidiaries in computing subsidiary capital, resulting in a higher indirect attribution of expenses to subsidiary capital.
In Petition of The Racal Corporation and Decca Electronics. Inc., Administrative Law Judge Unit, March 5, 1992, interest income received by a "grandparent" corporation from its second-tier (or lower) subsidiaries was deemed to be excludible from entire net income (as income from subsidiary capital) where the grandparent could establish beneficial ownership of more than fifty percent of such subsidiary's voting stock. The holding may affect the numerator of the indirect attribution formula by forcing taxpayers to reclassify investments in, and loans to, second-tier (or lower) subsidiaries as subsidiary capital. Such reclassification would result in a higher indirect attribution of expenses to subsidiary capital. It should be noted that the Division of Taxation has appealed the decision. In addition, Xerox Corporation is contesting the same issue at the Administrative Law Judge Unit level.
Certain planning strategies are available to minimize the impact of an expense attribution adjustment. For example, filing on a combined basis may negate the impact of expense attribution through the elimination of subsidiary capital. This strategy should be considered in view of the holdings in Autotote Limited, and A.G. Becker Paribas Group as discussed above. If combined reporting is not feasible, other strategies should be considered, including performing an expense attribution study, and focusing on the components of the expense attribution formula with a view towards reducing the overall attribution percentage.
Based on the above, taxpayers should implement the following action plan with respect to combined reporting in New York.
* Review the costs and benefits of filing on a combined basis.
* Review which companies should be included in the combined report.
* Analyze the tax impact of combination in the current year, future years, and prior years still open under the statute of limitations.
* If combination is beneficial, prepare and timely file a written request for permission to file on a combined basis (the deadline for calendar year taxpayers to request permission to file a combined report is January 30, 1993).
-- Establish detailed documentation supporting the elements of combination in conjunction with the combined report request.
-- If such detailed information is not available as of the combined report request deadline, a simplified request should be submitted, with the detailed information to be provided at a later date.
* Consider the implications of filing on a combined basis retroactively in light of the holdings in Autotote Limited, Chudy Paner and A.G. Becker Paribas Group.
* If retroactive combination is beneficial, this issue should be raised as part of the audit process.
-- If combination is detrimental, review the potential exposure associated with forced combination.
* Review the pricing of intercompany transactions to determine whether arms length pricing can be established to rebut the presumption of distortion stemming from substantial intercorporate transactions.
* Consider whether the holdings in Standard Manufacturing, Campbell Sales and Pharmaceutical provide a basis to invalidate any previous combined filings.
Review the potential exposure associated with the disallowance of expenses attributable to subsidiary capital.
Consider planning strategies to minimize the impact of an expense attribution adjustment.
-- Combined reporting.
-- Expense attribution study.
-- Reduce expense attribution percentage.
The potential tax savings in combined reporting are worth the effort of developing an action plan if the requirements can be met. The deadline for requests to file on a combined basis for 1992 is January 30, 1993. Time is short.
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