Editor: Greg A. Fairbanks, J.D., LL.M.
The use of mandatory unitary combined reporting has become increasingly popular among states in recent years. West Virginia, Massachusetts, and Wisconsin each unveiled combined reporting regimes for tax years beginning on or after January 1, 2009, and more states are likely to follow in the near future. The increased acceptance of mandatory unitary combined reporting has been driven by state budgetary shortfalls and the perceived distortion of taxable income by multistate corporations filing separate company reports.
Unitary Business Group
A characteristic permeating each state’s reporting methodology is a broadly defined concept of the unitary business group. West Virginia defines a unitary business as a single economic enterprise made up of separate parts of a single business entity or of a commonly controlled group of business entities. They must be “sufficiently interdependent, integrated and interrelated through their activitiessoastoprovideasynergyandmutual benefit that produces a sharing or exchange of value among them and a significant flow of value to the separate parts” (WV Code §11-24-3a(43)). A proposed regulation measures common ownership as more than 50% of the voting control of one or more corporations directly or indirectly owned by one or more common owners, whether corporate or noncorporate (WV Code St. Prop. R. §110-24-3.2.3). Insurance companies are excluded from the combined group, while regulated investment companies (RICs) and real estate investment trusts (REITs) are included (WV Code §§11-24-13a(j), 11-24-4b(a), (c)). While a partnership itself is not subject to corporate income tax, it can be viewed as a conduit for corporations to be included in a unitary group (WV Code §11-24-3a(31)).
Similar to West Virginia, a Massachusetts unitary business is defined to include the activities of a commonly owned group that are “sufficiently interdependent, integrated or interrelated through their activities so as to provide mutual benefit and produce a significant sharing or exchange of value among them or a significant flow of value between the separate parts” (MA Gen. Laws ch. 63, §32B(b)(1)). The concept will be construed to the broadest extent permitted under the U.S. Constitution. “Common ownership” is broadly defined as more than 50% control of voting power of each member, through direct or indirect ownership by a common owner(s), whether such ownership is through corporate or noncorporate entities and regardless of whether such owner(s) are members of the combined group (MA Gen. Laws ch. 63, §32B(b)(2)). Foreign corporations, financial institutions, utility companies, and certain life insurance companies, as well as federally qualified RICs and REITs, are subject to combination (MA Gen. Laws ch. 63, §32B(c)(1)).
A Wisconsin unitary business can consist of separate parts of a single business entity, multiple business entities that are related under Secs. 267 or 1563, or a commonly controlled (more than 50%) group of business entities. In addition to using the flow of value test and the three unities test, a variety of unitary business tests used in other combined reporting states are referred to, but the statute reserves the right to broadly construe the concept to the extent permitted by the U.S. Constitution (WI Stat. §71.255(1)(n)).
Water’s Edge and Other Filing Elections
A West Virginia combined group is required to file on a water’s-edge basis, unless the group elects to file on a worldwide combined basis (WV Code §§11-2413f(a), (b)). The worldwide election must be made on a timely filed, original return by every member of the unitary business subject to tax (WV Code §11-24-13f(b) (1)). The election is binding and irrevocable for 10 years. Withdrawal must be made in writing within one year of the expiration of the election period, and such determination is likewise binding for 10 years. If no withdrawal is made, a new 10 years of worldwide combined reporting will begin (WV Code §11-24-13f(b)(5)).
A Massachusetts combined group may elect to file on a worldwide basis or, by default, to file on a water’s-edge basis (MA Gen. Laws ch. 63, §32B(c)(3)). A taxpayer filing on a water’s-edge basis may elect to treat as its Massachusetts combined group all corporations that are members of its affiliated group, including all its water’s-edge members (MA Gen. Laws ch. 63, §32B(g)(ii)). An “affiliated group” means a group as defined in Sec. 1504 (using a more than 50% common ownership test) and includes any corporation that meets the Massachusetts water’sedge description.
Both the worldwide and U.S. affiliated group elections must be made on an original, timely filed return by any member of the combined group in the first tax year in which the election will be in effect, and such elections are irrevocable for 10 years. After the initial period, the election may be revoked or renewed for another 10 years. If a prior-year affiliated group election is neither affirmatively revoked nor renewed, the election will terminate and the group will not be permitted to reapply in any of the three years following the revocation (830 MA Code Regs. §63.32B.2(10)(f)). In addition, any corporation entering the affiliated group subsequent to the year of election must be included in the Massachusetts combined group and is considered to have waived any objection to the inclusion (MA Gen. Laws ch. 63, §32B(g)(ii)).
A Wisconsin combined group must include corporations that meet its specific water’s-edge test. No worldwide election is available. However, the combined reporting statute was amended in 2009 to allow an election to include every corporation in a commonly controlled group regardless of whether such corporations are engaged in the same unitary business (WI Stat. §71.255(2m)). If this election is made, however, the return cannot report any allocable income. The election is executed on an original, timely filed combined report and does not need prior approval from the Wisconsin Department of Revenue. The election is binding for 10 years, and any corporation that subsequently becomes included in the commonly controlled group is considered to have waived any objection to its inclusion. If the election is not timely renewed, it is considered revoked, and a new election will not be permitted in any of the three years following the revocation (WI Stat. §71.255(2m)(c)).
Water’s-Edge Group Membership
A West Virginia water’s-edge group consists of combined group members that:
- Are incorporated or formed in the United States;
- Have apportionment factors in the United States averaging 20% or more;
- Are domestic international sales corporations, foreign sales corporations, or export trade corporations;
- Are members not included in the first three categories that have business income effectively connected with the conduct of a trade or business within the United States;
- Are controlled foreign corporations;
- Earn more than 20% of their income from intangible property or service-related activities, the costs of which are generally for federal income tax purposes deductible against business income of other water’s-edge group members; or
- Are doing business in a “tax haven” (WV Code §11-24-13f).
Massachusetts water’s-edge members consist of entities that are incorporated or formed in the United States; are incorporated or formed anywhere with at least a 20% average of property, payroll, and sales factors within the United States; or earn more than 20% of their income from intangible property or service-related activities, the costs of which generally are deductible for federal income tax purposes against business income of other group members (MA Gen. Laws ch. 63, §§32B(c)(3)(i), (ii), and (iii)).
In Wisconsin, the water’s-edge test determines whether and to what extent a foreign corporation is includible in a combined report, as well as whether any of a domestic corporation’s foreign-source income is includible in the combined report. According to a rule promulgated by the Wisconsin Department of Revenue, rather than a set listing of companies that are automatically included in the water’s-edge group, three factors control an entity’s status as includible or excludible: whether the corporation is foreign or domestic, whether the corporation is an 80/20 corporation (80% or more of its worldwide gross income is “active foreign business income” as defined in the Code), and whether the corporation’s income is foreign source or U.S. source (WI Admin. Emergency R. §2.61(4)).
Calculation of Taxable Income
In West Virginia, each member is responsible for tax based on its taxable income or loss apportioned or allocated to West Virginia. This includes the member’s apportioned share of the combined group’s business income. A member’s net business income is determined by removing all but business income, expense, and loss from that member’s total income. Each member calculates its income or loss by including income apportion-able to West Virginia from each of the combined groups in which the entity is a member, income from distinct multistate business activities, income from a business performed solely in West Virginia, income sourced to West Virginia from the sale or exchange of capital or assets and from involuntary conversions, allocable nonbusiness income or loss, allocated/ apportioned income or loss in an earlier year sourced to the state, and net operating loss (NOL) carryovers. The taxpayer’s share of the business income apportion-able to West Virginia of each combined group of which it is a member is the product of the combined group’s business income and the member’s apportionment percentage associated with the combined group’s unitary business (WV Code §§11-24-13c(a)–(c)).
Each taxable member of a Massachusetts combined group engaged in a unitary business is subject to tax on its taxable income or loss apportioned or allocated to Massachusetts. This includes the taxpayer’s share of any unitary business income apportionable to Massachusetts for each of the combined groups of which it is a member, share of any income apportionable to Massachusetts of a distinct business activity conducted within and outside Massachusetts by the taxable member, income from a distinct business conducted by the taxable member entirely within Massachusetts, income or loss allocable to Massachusetts, and NOL carryforward (830 MA Code Regs. §63.32B.2(6)(c)).
Under a proposed regulation, a Wisconsin combined group member’s taxable income consists of the total of its apportioned share of the combined unitary income; apportioned share of the unitary business income not subject to combination under the water’s-edge rules; apportioned share of income from a distinct business activity conducted within and outside Wisconsin; income from a distinct business activity conducted entirely within Wisconsin; nonbusiness income or loss allocable to Wisconsin; income realized from the purchase and subsequent sale of Wisconsin lottery prizes; income, loss, or deduction allocated or apportioned in an earlier year that is taken into account as Wisconsin source income or loss during the tax year; and NOL carryforwards (WI Admin. Emergency R. §2.61(5)).
Apportionment and Joyce-Finnigan Methodology
West Virginia combined group members must utilize a three-factor formula comprising property, payroll, and double-weighted sales. West Virginia has proposed that it will follow the Joyce approach beginning January 1, 2009 (Ap peal of Joyce, Inc., No. 66-SBE-070 (Cal. State Bd. of Equalization 11/23/66)). Under Joyce, the sales of members with their own nexus to the state are included in the numerator of the sales factor. Sales into the state by any member without nexus are excluded from the numerator. The effect of West Virginia’s “throwout” rule, under which all destination sales to states where the taxpayer transacts no business, where no business is subject to a corporation income tax, or where the destination state lacks jurisdiction to impose a corporation net income tax are eliminated from the denominator, is likely to be adverse to taxpayers when the Joyce rule is employed (WV Code St. Prop. R. §110-24-7.18.2).
Each taxable member of a Massachusetts combined group separately determines apportionment using a formula based on that member’s individual business classification. Different apportionment formulas are used for general business, manufacturing, financial, utility, and mutual fund corporations. When determining the sales factor, the numerator must contain what Massachusetts refers to as a Finnigan adjustment (pursuant to Appeal of Finnigan Corp., No. 88-SBE022-A (Cal. State Bd. of Equalization 1/24/90)). Where a group contains taxable and nontaxable members, the numerator of the taxable members is increased by a percentage of the total amount of sales of all nontaxable members sourced to Massachusetts.
Each taxable member is required to compute a fraction, the numerator of which is the member’s Massachusetts sourced sales, and the denominator is the sum of the Massachusetts sourced sales of all taxable members. This fraction is then multiplied by the total Massachusetts sourced sales of the nontaxable members and finally added to the taxable member’s sales numerator. There is some relief for taxpayers under the Finnigan adjustment in the application of Massachusetts’s throwback rule, whereby taxable members are considered taxable in any state in which any member of its combined group is subject to tax on income derived from the unitary business. The denominator(s) of the apportionment formulas that apply to each taxable member will be the total property, payroll, and/or sales of the combined group as a whole. The total is determined by summing the denominators of all members, taxable or nontaxable, of the combined group as individually determined (830 MA Code Regs. §§63.32B.2(7)(a)–(d)).
In Wisconsin, each corporation in the group will multiply the combined group’s income by an apportionment percentage. Most companies will compute the apportionment percentage by using a single sales factor. The numerator of the sales factor will be the separate company’s sales factor and the denominator will be the sum of the denominators of all group members’ sales factors. Corporations in specialized industries that require the use of a multiple factor apportionment percentage will compute the percentage on a separate company basis and then convert it to a sales formula for purposes of filing combined. The multiple factor percentage is multiplied by the company’s total sales in order to achieve the numerator of the sales factor. The denominator will be the sum of the total sales of each of the group members. Wisconsin also increased its throwback percentage to 100% for years beginning on or after January 1, 2009. Since Wisconsin follows Finnigan, when a group member computes its numerator, that member should not throw back sales destined for a state where any combined member has nexus.
Treatment of NOLs and Credits
West Virginia allows an NOL carryover earned during a tax year in which the taxpayer filed a consolidated return to be applied as a deduction from taxable income of any member of the controlled group until it is used or expires. NOLs earned otherwise may only be applied to the member that generated the loss (WV Code §11-24-13c(b)(1)(G)). In general, credits earned by a combined group member may not be used to offset the tax liability of another member. However, unused economic development tax credits that were earned during a year in which the taxpayer filed a consolidated return may be used against any member of the taxpayer’s combined group to the extent the credits would have been allowed had the taxpayer continued to file a consolidated return (WV Code §11-24-13c(b) (2)).
Beginning January 1, 2009, a Massachusetts taxable group member that generates an NOL carryforward from the activities of the combined group generally may share it with the other taxable members that were members of the group when the NOL was generated, following deduction from the member’s own post-apportioned taxable net income derived from the combined group. Since NOLs are considered separate tax attributes, if a taxable member ceases to be a part of the combined group, any NOL carryforward owned by that taxpayer is no longer available to be shared by any other taxable members of the group with which the taxpayer was previously affiliated. If a taxable member has an NOL carryforward generated in a year beginning prior to 2009, it is available only to the taxpayer that incurred the loss and cannot be shared with other taxable members of the group (830 MA Code Regs. §§63.32B.2(8)(a)–(d)).
Beginning January 1, 2009, a credit that may be claimed by a taxable member that is attributable to the combined group’s unitary business generally may be shared with the other taxable members. Credits must first be applied against the excise of the taxpayer that generated the credit and then against the excise of the other taxable members that are eligible to share the credit. In the case of credits generated prior to 2009, a credit carryforward may be shared as long as the sharing is consistent with the rules in effect at the time the credit was generated. To the extent that the rules required a combined return to be filed in order to share the credit, the taxpayer must have filed a combined return with the other taxable members seeking to share the credit in the last tax year beginning prior to January 1, 2009 (830 MA Code Regs. §§63.32B.2(9) (a)–(c)).
In Wisconsin, if a member has a net business loss in years beginning on or after January 1, 2009, the loss can be used to offset unitary income of another member. In response to public input, new language was added in June 2009 to “simplify” the calculation because it did not distinguish between pre-and post-apportionment losses. This simplification will change how the losses are computed and may allow opportunities to optimize the utilization of the losses. A technical correction was made to allow a member of a combined group with an unused research or research facilities credit carryforward to use that credit to offset the tax liability of all other members of the combined group on a proportionate basis, to the extent such tax liability is attributable to the unitary business. However, no correction was made to allow for the sharing of any other credits (WI Stat. §§71.255(6)(a)–(c)).
The next few months are likely to result in a number of refinements to the filing methodologies in West Virginia, Massachusetts, and Wisconsin as taxpayers submit the first combined filings. At the same time, states’ regulations are still being clarified and finalized, and potential technical corrections bills are being considered. One of the biggest challenges being faced by the states is the timely development of forms and instructions that will accurately carry out the statute’s intent while providing clarity to taxpayers. In some of the states, this may also mean developing forms that taxpayers can file on systems capable of handling electronic submissions. Meanwhile, taxpayers need to continue to monitor other states and the District of Columbia considering mandatory unitary combined reporting in the near future. These developments are likely to create an additional burden for some taxpayers, particularly when determining the members of the combined group.
Greg Fairbanks is a tax manager with Grant Thornton LLP in Washington, DC.
Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.For additional information about these items, contact Mr. Fairbanks at (202) 521-1503 or firstname.lastname@example.org