Current corporate income tax developments.

EXECUTIVE SUMMARY

* In Hunt-Wesson Inc. v. FTB, the U.S. Supreme Court held that California's interest-deduction offset provision is not a reasonable allocation of expenses to income and is impermissible taxation of income outside the state's jurisdiction.

* An alien corporation operating in New York had to include foreign-source income on its franchise tax return, even though such income was not included on its Federal return.

* Effective Jan. 1, 2000, the Michigan legislature made substantial changes to the SBT, including its application to foreign persons.

This two-part article discusses a plethora of recent state pronouncements issued in the corporate income tax area. Part I addresses nexus and tax base; Part II, in the next issue, examines apportionment, administration and other developments.

During 2000, an overwhelming number of state statutes were added, deleted or modified; court cases were decided; regulations were proposed, issued and modified; and bulletins and rulings were issued, released and withdrawn. Because it is impractical to summarize all of these activities, Part I of this two-part article focuses on some of the more interesting items in the corporate income tax areas of nexus and tax base. Part II, in the April 2001 issue, will discuss apportionment, administration and other significant income tax and nonincome tax developments.

Nexus

Application of P.L. 86-272

P.L. 86-272 prohibits a state from taxing a business when its only connection with the state is the solicitation of orders for sales of tangible personal property sent outside the state for approval or rejection and, if approved, are filled and shipped by the business from a point outside the state. Several cases, rulings and legislative bilk addressed whether a taxpayer's in-state activities fell within the protection of P.L. 86-272.

* Illinois

An appellate court held that the maintenance of an unmanned office and registration of a phone line in the state in connection with the registration of a truck fleet there created nexus for corporate income tax purposes.(1) The taxpayer leased an office for $500 per year; however, it did not otherwise take possession of or occupy the leased premises, did not own the property in the office and had no employees there. The court held that the maintenance of an office in the state exceeded the protection of P.L. 86-272 and that the ancillary and de minimis exceptions, did not apply. Further, the court held that even if the exceptions did apply, the taxpayer's activities were not ancillary to solicitation, because registration of its truck fleet under the international registration plan and maintenance of an office in Illinois served an independent business function apart from soliciting or delivering orders.

* Illinois

The DOR ruled that deliveries to in-state customers using company-owned vehicles or owned or leased railcars would establish nexus with the state, unless such activities were de minimis.(2)

* Texas

The Comptroller of Public Accounts ruled that if a manufacturer's only contact with Texas was the delivery of its product via its own trucks, it did not have nexus for purposes of the earned surplus component (which is based on taxable income).(3) An administrative law judge (ALJ) agreed with the petitioner that the delivery of goods into a state in company-operated vehicles, regardless of the frequency, is protected by P.L. 86-272.

* Virginia

The Department of Taxation (Department) ruled that the taxpayer's bundling of warranties (including parts and repairs) at its out-of-state facilities with its products did not exceed P.L. 86-272 protection, but warranty services carried on in Virginia are not protected.(4) The taxpayer did not provide onsite warranty service with its own employees; such warranties are purchased by the taxpayer from an unrelated third-party warrantor, who provides all needed onsite service.

The Department views these activities as if the taxpayer is purchasing the warranty services from a vendor and reselling them to its customers. Although P.L. 86-272 only applies to the sale of tangible personal property, Virginia applies the same "solicitation" test to sales of intangible personal property. Under these circumstances, sales of services on behalf of an independent third party would not create nexus for a corporation otherwise protected under P.L. 86-272. The Department will, however, take a different approach if a third-party warrantor is not independent of the taxpayer. The Department attributes unprotected activities performed by a party not independent to a corporation in determining whether the corporation has nexus with Virginia. Thus, a third-party onsite warrantor not independent of the taxpayer would be deemed to be providing services on the taxpayer's behalf to its customers.

Trademark/Tradename Companies

* Maryland

A circuit court upheld two decisions of the state tax court that an out-of-state Delaware subsidiary holding and managing trademarks, service marks and tradenames for an affiliated group is not subject to Maryland corporate income tax, because the affiliate is a nonphantom entity (i.e., it has substance).(5) Both decisions have been appealed to the state's highest court.

* New Mexico 

The Taxation and Revenue Department (T&R Department) held that Kmart Properties, Inc. (KPI) was subject to franchise and gross receipts taxes.(6) KPI, a Kmart subsidiary, owned trademarks and tradenames and licensed them to Kmart retail locations doing business in the state. During the litigation, the T&R Department requested and received memoranda explaining how to set up a trademark company, how to operate it and the expected state tax savings. The trademark company generally operated with independent substance as a separate company: it moved into a separate building; it employed all of the trademark attorneys; any work done by the trademark attorneys for the other Kmart companies was billed at an hourly rate; and there were executed loan documents between Kmart and the trademark company (however, the loan documents provided for loans up to $500 million, much lower than the actual outstanding balance).

In attacking KPI, the T&R Department relied on trademark law, which provides that trademarks cannot be separated from goodwill; in essence, a trademark has no value (or would be considered abandoned) unless it is maintained by an ongoing business. The T&R Department also looked at the licensing requirements under trademark law, which require a licensor to maintain, control and protect a trademark. It found that there was substantive identity between KPI and Kmart, based on a direct correlation between Kmart's use of KPI's trademarks in New Mexico to promote sales and enhance its sales revenues and the revenues KPI receives as royalties (calculated as a percentage of those New Mexico sales). It further found that the Uniform Division of Income for Tax Purposes Act's (UDITPA's) three-factor formula did not fairly represent KPI's business activity in New Mexico, because its only business activity in the state is the licensing of its trademarks for use there. In addition, the T&R Department upheld the gross receipts tax assessment on KPI's royalty income in New Mexico, finding that payment of the royalties is a condition of the sale and is the consideration for the sale to the extent the sale occurs in the state. The decision has been appealed.

* North Carolina 

The Assistant Secretary of Revenue ruled that nine nondomiciliary trademark holding companies are doing business in the state for corporate and franchise tax purposes, despite the fact that none of the companies has had offices or employees in the state.(7) The holding companies licensed trademarks, tradenames and service marks to related North Carolina retail stores, and the parties engaged in numerous intercompany-lending transactions.

Other Nexus-Creating Activities

* Georgia

The DOR proposed amending Reg. 560-7-7-.03 to provide that a corporation that is a limited or general partner in a partnership doing business or owning property in the state is subject to state corporate income tax.

* Illinois

An appellate court held that owning a limited partnership interest in a limited partnership doing business in the state is sufficient nexus to subject a corporate partner to the Illinois personal. property replacement income tax.(8) The taxpayer also challenged Illinois rules that do not allow the flowthrough of the investment tax credit (ITC) from an operating partnership to a corporate taxpayer; the taxpayer prevailed on this issue and could flow through the partnership's ITC.

* Illinois

An ALJ ruled that a Wisconsin corporation that rented and leased trucks to commercial businesses (including businesses located in Illinois) was not subject to Illinois corporate income tax, because it did not have sufficient contact with the state to satisfy either the Due Process or the Commerce Clause.(9) Under the terms of the lease agreements, the lessee has complete dominion and control over the leased vehicles. In addition, none of the lessees took possession of the vehicles in Illinois.

* Maine

The Bureau of Revenue Services modified Rule 808 (corporate income tax nexus) in May 2000. The most significant of the amendments provides that the activities in Maine of an independent contractor on behalf of a foreign corporation will be imputed to the corporation if they are more than de minimis and significantly associated with the latter's ability to establish and maintain a market in Maine, to the extent allowed by the U.S. Constitution and Federal law.

* Maryland

A circuit court denied the Comptroller's attempt to impose an income tax on an out-of-state entity based on the in-state presence of an affiliate and intangible assets.(10) The Comptroller attempted to reallocate interest flowing from an in-state entity to an alleged out-of-state "phantom entity," MCI International Telecommunications Corp. (MCIIT), and to attribute nexus from the m-state entity to MCIIT. The court affirmed the state tax court's finding that the presence of property, officers, operating territory, employees and expenses proved that MCIIT was not a phantom corporation. Because MCIIT was not a phantom corporation and conducted no activity in Maryland, it was not subject to its taxing jurisdiction. This decision has been appealed to the state's highest court.

* Massachusetts

The Appellate Tax Board (ATB) held that a corporation that sold a variety of nutritional, household and personal-care products through independent contractors was not subject to sales, use or corporate excise tax.(11) In reaching this conclusion, the ATB relied heavily on its decision in Jafra Cosmetics, Inc. v. Comm'r of Rev.(12)

* Michigan

Effective Jan. 1, 2000, the application of the single business tax (SBT) to foreign persons has been modified. Foreign companies doing business in Michigan (beyond remote selling) are now required to pay SBT even if they do not have a permanent establishment in the state.(13) According to Revenue Administrative Bulletin (RAB) 1999-10,(14) foreign persons (other than insurance companies and certain nonprofit persons) not subject to Federal income taxes under the Internal Revenue Code (IRC) and/or a provision in an applicable income tax treaty for tax years beginning before 2000 are not required to file a SBT return for those years.

* Michigan

RAB 1999-9(15) explained that the income, deductions, credits, assets and liabilities of a single-member entity (SME) having nexus with Michigan, which elects to be disregarded as an entity for Federal income tax purposes, are deemed to be those of the owner. Thus, the owner of the disregarded entity has nexus with Michigan by virtue of the SME's property and activities in the state.

* Michigan

RAB 2000-5(16) describes the effect of a Federal qualified subchapter S subsidiary (QSub) election on Michigan taxes. For SBT and individual income tax (IIT) purposes, a parent and/or subsidiary has nexus with Michigan by virtue of the property and activities of either. The nexus standard for SBT is explained in RAB 1998-1(17) and differs from the income tax standard that still relies on P.L. 86-272, related constitutional limits and case law to determine when a taxpayer is taxable in another state.

* New Jersey

The Division of Taxation (Division) has suspended all rulings (unnamed and named) on the issue of corporate limited partner nexus. Further, the Division has issued an audit assessment against an out-of-state corporate limited partner, which has been contested and is presently in administrative appeals. The Division intends to litigate the assessment in an effort to establish a judicial precedent (i.e., that the corporation business tax may be imposed on foreign corporate limited partners).

* New York City 

An ALJ ruled that a foreign corporation whose only connection with the city was its general partnership interest in a New York general partnership, whose only connection with the city, in turn, was the holding of a passive limited partnership interest in a partnership that owned real property in the city, is subject to the general corporation tax (GCT).(18) The ALJ determined that GCT Reg. [sections] 1-5 (now 19 RCNY [sections] 11-06) may be applied retroactively in this case, because such application would not prejudice the taxpayer (i.e., the taxpayer suffered no detrimental reliance, because it had paid the GCT before a 1998 letter ruling, believing the tax was legally owed).

* New York City

An ALJ ruled that a limited partner in a New York partnership that owns property in the city is subject to the GCT.(19)

* Ohio

The Board of Tax Appeals determined that a foreign corporation whose only contact with the state was as a limited partner in a limited partnership doing business in Ohio was not subject to state corporate franchise tax.(20) The corporation never had a physical presence in Ohio and was nothing more than a passive investor in the limited partnership. Its limited partnership interest was not includible in the property and business-done factors of the net-worth calculation, because the situs of the ownership interest was the corporation's commercial domicile, not Ohio. Based on this decision, an Ohio corporate taxpayer whose only contact with the state is through a passive investment in a limited partnership, should not be liable for state franchise tax for calendar or fiscal years ending before Sept. 28, 1997.

* Tennessee

A case addressed the constitutionality of the state's economic nexus standard, under which a financial institution is subject to tax if it has sufficient business contacts in the state (even if it has no physical presence there).(21) The Tennessee Court of Appeals reversed a chancery court decision and held that J.C. Penney National Bank (JCPNB) did not have substantial nexus with the state. In so doing, the court rejected as not "constitutionally significant" the chancery court's finding that the taxpayer's 11,000 to 17,000 credit cards in Tennessee constituted a physical presence. The court also rejected the chancery court's findings that the unaffiliated retail stores operated by JCPNB'S parent gave JCPNB physical presence in Tennessee. The state supreme court denied permission to appeal; the U.S. Supreme Court denied certiorari.

* Texas

An appeals court clarified that a royalty company has to do more than hold a certificate of authority from the Secretary of State before the Comptroller can impose the franchise tax.(22) The state supreme court denied the state's petition for review.

* Wisconsin

Effective for tax years beginning after 1999, under Act 9, Laws 1999, a foreign corporation will not have nexus with Wisconsin and will not be subject to the corporate income and franchise tax if its only connection with the state is storing the foreign corporation's tangible personal property for no more than 90 days in or on property owned by a person (other than the foreign corporation), if (1) such property is transferred to the person and is used in the state by the person for fabricating, processing, manufacturing or printing on the parcel of property in or on which the tangible personal property is stored; and (2) the parcel had an assessed value, for property tax purposes, of at least $10 million (but not more than $11 million) on Jan. 1, 1999.

Entity Classification Conformity

* Florida

In Technical Assistance Advisement No. 00C1-00, the DOR responded that a partnership electing to be treated as an association for Federal income tax purposes could be part of an affiliated group filing a Florida consolidated income tax return. According to the DOR, the partnership would be treated for Florida income tax purposes in the same manner as it is for Federal income tax purposes.

* Michigan

RAB 1999-9 described the application of Federal entity classification election (check-the-box) regulations to the SBT and IIT. Michigan conforms to the Federal check-the-box regulations; a taxpayer that elects entity classification at the Federal level must file its SBT return on the same basis and reflect the same tax consequences. The election of entity classification for Federal income tax purposes is also effective on the Michigan IIT return of the individual, shareholder, partner or member, whether the taxpayer is a Michigan resident or nonresident; no separate election is required.

The property, payroll and sales (or special formulas for certain businesses) of the combined entities are used to determine the apportionment factors for SBT and IIT of an SME and its owner if the SME is disregarded at the Federal reporting level. Inter-entity sales between the SME and its owner are disregarded when computing the sales factor.

* Michigan

RAB 2000-5 describes the effect of a Federal QSub election on Michigan taxes. The state conforms to the Federal QSub election for SBT purposes; thus, a QSub is disregarded as an entity and the S corporation and QSub must file a single return. No separate QSub election is required or allowed at the state level. The property, payroll and sales (or special formulas for certain businesses) of the combined entities are used to determine the apportionment factors for SBT and IIT of an S corporation and its QSub.

* New York

The Department of Taxation and Finance ruled that a registered limited liability partnership (RLLP) that elects to be taxed as an association for Federal income tax purposes is taxed as a corporation for state corporate franchise (income) tax purposes.(23) An RLLP treated as a partnership for Federal income tax purposes is treated as a partnership for New York State tax purposes.

State Tax Base

The majority of states imposing a corporate income-based tax begin the computation of state taxable income with taxable income as shown on the Federal corporate income tax return (Form 1120, U.S. Corporation Income Tax Return). These states use either taxable income before net operating loss (NOL) and special deductions (Line 28) or taxable income (Line 30); certain state-specific addition and subtraction modifications are then applied to arrive at the state tax. base. Below is a summary of the recent significant changes to the states' tax base.

Apportionable Income (Business/ Nonbusiness Income)

Under UDITPA, a multistate corporate taxpayer's income is divided into two classes--business income and nonbusiness income. Business or apportionable income is divided among all of the states in which the corporation has nexus by use of a statutory apportionment formula; nonbusiness income is generally assigned to the state in which the corporation is domiciled or the property that was disposed of is located. UDITPA generally defines "business income" as income arising from transactions and activity in the regular course of a corporation's trade or business and includes income from tangible and intangible property if the acquisition, management and/or disposition of the property constitute integral parts of the corporation's regular trade or business. All other income is nonbusiness income.

The courts are split as to whether the UDITPA business income definition requires that both (1) the transaction giving rise to the income is in the regular course of the corporation's income (transactional test) and (2) the acquisition, management, use and disposition of the property are integral parts of the corporation's regular business operations (functional test).

In addition to UDITPA'S business/nonbusiness distinction, a state is prohibited under Allied-Signal, Inc.(24) from taxing income not generated in the course of a corporation's unitary business. Such income would not be includible in the corporation's apportionable income.

* Alabama

The state supreme court held that gain Uniroyal Tire Company recognized on the sale of a partnership interest constituted nonbusiness income.(25) The court held that the statute defining business income (Ala. Code Sec. 40-27-1, Art. IV, 1.(a)) includes only a "transactional" test, not a separate "functional" test. Under the transactional test, Uniroyal's disposition of its partnership interest did not generate business income.

* Alabama

An ALJ held that the state cannot constitutionally tax the dividend income of a nonresident corporate limited partner when that income has no connection to the state.(26) During the subject years, the taxpayer owned a 21% interest in a limited partnership that owned oil and gas interests in Alabama, 2,000 acres of timberland in Florida and a large stock portfolio that included a "permanent" (long-term investment) portfolio and an "investment" (actively traded) portfolio. The ALJ held that while dividends can be apportioned to Alabama if the underlying stock served an operational function in the taxpayer's business, the operational function must relate to the taxpayer's activities in the taxing state. Even if the dividends constituted business income, there was no connection between the out-of-state operational functions for which the dividends were used and the taxpayer's activity in Alabama. Consequently, the ALJ held that Alabama is constitutionally prohibited from taxing the dividends.

* California

The State Board of Equalization (SBE) held that interest and dividend income from two long-term investment funds was business income.(27) Consolidated Freightways Inc. (CFI) is a freight transportation company domiciled in California. In 1981, CFI sold a subsidiary and intended to use the sale proceeds to purchase another company to expand its share of the transportation-service industry. In early 1989, CFI's long and arduous search for an appropriate target came to fruition. Although availability and liquidity have never been held to be the primary determining factors for an SBE determination regarding business income, "the fact that proceeds were managed to make them readily accessible, liquid, and available for immediate use with no prepayment penalty, while [CFI] was engaged in an active, ongoing effort to acquire a compatible business, is strong evidence that these funds were earmarked for an acquisition target in the transportation industry." Thus, the interest and dividend income was business income.

* Illinois

An appellate court ruled that the state cannot tax a nonresident corporation's income from investments, except to the extent such investments were actually used as working capital.(28) Under the operational test, the court determined the DOR could tax only a portion of the taxpayer's income from its short-term investment accounts, because only part of those funds had been used as working capital. According to the court, the fact the investment and operational funds were not segregated does not render all the income generated from the short-term accounts apportionable. The court also concluded that the mere availability of investment funds for day-to-day operations of a nondomiciliary corporation in a short-term account does not provide sufficient connection between the corporation's activities and the taxing state to allow the latter to apportion interest income generated therefrom.

* Kansas

The state supreme court held that interest expense on a loan to defend against a hostile takeover was an allocable nonbusiness expense, nondeductible on the taxpayer's Kansas income tax return.(29) The court noted that the state legislature amended Kan. Stat. Ann. 79-3271(a) in 1996 to include the functional test for tax years after 1995. During the audit period, however, Kansas only applied the transactional test to determine if an item was apportionable business income. The court found that the controlling factor in the transactional test is the nature of the particular transaction giving rise to the income. The court affirmed the Kansas Board of Tax Appeals' determination that, under the transactional test, borrowing money to defend against a hostile takeover is not an expense in the regular course of business; thus, the resulting interest expense is a nonbusiness expense.

* Massachusetts

The ATB held that the distribution of pension reversion income from a subsidiary to its parent was excludible from state taxable income, because the subsidiary was being liquidated.(30) The ATB also ruled that the parent's share of such income should not be included in the denominator of its state apportionment factor, because it represented "gross receipts from the disposition of securities."

* North Carolina

In light of Polaroid Corp. v. Offerman,(31) the state supreme court ordered the state appellate court to reconsider its original nonbusiness income holding in Union Carbide Corp. v. Offerman.(32)

Fearing a hostile takeover after a 1984 chemical gas leak in Bhopal, India, Union Carbide adopted a restructuring plan designed to increase stock prices. As part of the corporate restructuring, Union Carbide effected a reversion of pension plan funds from its overfunded pension plan and used it to buy back company stock. The state supreme court affirmed the appellate court ruling, holding that Union Carbide's contingent property right in the pension plan was neither integral nor did it constitute part of Union Carbide's regular trade or business operations.(33)

* North Carolina

Effective July 1, 2000, the DOR amended Reg. 17:05C.0703 (governing the definition of business and nonbusiness income for multistate corporate income tax purposes) to conform it to the DOR'S current position. The new rule creates a presumption of business income, unless such income is clearly classifiable as nonbusiness income. In addition, property a taxpayer includes in the property factor for which it takes a deduction against income is presumed to be "an integral part of the taxpayer's regular trade or business operations."

* North Carolina

The court of appeals held that the proceeds from the complete sale of an operating division constituted nonbusiness income under the functional test.(34) The court articulated a "totality of the circumstances" application of that test for cases involving a partial or complete liquidation.

* Oregon

The state supreme court held that OAR 150-314.610(1)(B)(1) (the regulation defining business income) is invalid to the extent it treats income from property merely incidental to a taxpayer's trade or business as business income.(35) Applying the statutory definition of business income to the taxpayer's royalties, the court held that such income did not satisfy the transactional test, because receiving royalties on mineral rights was not in the regular course of the taxpayer's business as a forest products company. Similarly, the income did not satisfy the functional test; the disposition of the timberland (the property that produced the royalty income) was not an integral part of the taxpayer's regular business operations. Thus, the court held that, under the statutory definition of business income, royalties from out-of-state mineral rights were not business income.

* Oregon

The state tax court held that settlement proceeds were apportionable business income under both the transactional and the functional tests.(36) In December 1983, Pennzoil entered into a contract to merge with Getty Oil. At the same time, Texaco was secretly negotiating with Getty Oil to buy all of its stock, and entered into an agreement in January 1984. Pennzoil sued Texaco for improper interference with a contract; the parties settled in 1988 for $3 billion.

The court held that, in general, amounts received in litigation have the same character for income tax purposes as if collected without the need for a lawsuit. In analyzing the functional test, the court held that it was clear that at all times, Pennzoil was actively engaged in acquiring and disposing of interests in oil and gas assets as an integral part of its regular trade or business. Thus, the income arising from the Getty contract was business income under the functional test as well.

* Oregon

A tax magistrate granted summary judgment in favor of the DOR and held that the sale of an operating division was business income.(37) As a condition of a merger involving its parent, the Federal Trade Commission (FTC) required Sandoz Agro to be divested. The first step was to sell its crop protection division (i.e., inventory and other assets) at a gain, which the taxpayer characterized as ordinary income apportionable to Oregon; it characterized the gain on the sale of fixed assets and goodwill as nonbusiness income. As to application of the transactional test, Sandoz Agro argued that the FTC-ordered divestiture was not part of its regular course of business.

The magistrate held that the involuntary nature of the transaction had no role. The fixed assets were previously depreciated and used to offset business income. They were also included in Sandoz Agro's property factor for apportionment purposes; thus, the fixed-asset gain was business income. The goodwill was created by the business operations of the assets and was also business income.

In applying the functional test, the magistrate noted the test requires that the (1) acquisition, (2) management, use or rental and (3) disposition must be an integral part of the taxpayer's regular trade or business operations. Returning to the stipulation that the fixed assets had been depreciated, the magistrate held that the sale satisfied the functional test. Goodwill was also an integral part of Sandoz Agro's regular business, and thus business income.

DRD 

* California

The state court of appeal held that the statute limiting the franchise tax dividends-received deduction (DRD) for dividends received from insurance company subsidiaries violates the Commerce Clause.(38) According to the court, Cal. Rev. & Tax Code [sections] 24410 violated that clause in two ways: by (1) allowing a deduction for insurance subsidiary dividends only to corporations domiciled in California and (2) limiting the DRD under a formula based on the subsidiary's gross receipts, payroll and property in the state. Cases addressing the constitutionality of the DRD for general corporations under Cal. Rev. & Tax Code [sections] 24402 are pending.(39)

* Florida

A district court of appeal held that a pre-1993 statute that did not allow a DRD for dividends from foreign subsidiaries did not violate the Foreign Commerce Clause.(40) Similar to the Kansas Supreme Court's decision in Morton Thiokol, Inc.,(41) the Florida court distinguished Kraft Gen'l Foods, Inc. v. Iowa Dep't of Rev. and Fin.,(42) on the basis that, under the Florida consolidated reporting methods employed by the taxpayer, all of its domestic income (including dividends) was, in one form or another, included in its corporate tax base and ultimately subject to Florida corporate tax--just as were those received from its foreign subsidiary. Thus, the court held that the dividends from the taxpayer's foreign subsidiary were not given less favorable treatment than those received from its domestic subsidiaries. For tax years beginning after 1992, Florida law was amended to allow a subtraction from Federal, adjusted income for both foreign and domestic dividends.

* Ohio

The state supreme court ruled that Ohio Rev. Code [sections] 5733.04(I)(2)(c), which provides for only an 85% DRD for dividends received from a foreign subsidiary (but a 100% DRD for those received from a domestic subsidiary), violates the Foreign Commerce Clause.(43) The state tax commissioner attempted to distinguish Kraft on the grounds that Ohio, unlike Iowa, permits combined-income reporting. However, the court noted that an Ohio combined report can include only those subsidiaries that earn income in the state. For subsidiaries without such earned income, the state's tax system does not differ from the single-entity reporting method involved in Kraft.

NOL Deduction

* California

AB 511, Laws 2000, increased the percentage of NOLs that can be carried forward and doubled the carryforward period. The general carryforward percentage was increased from 50% to 55% for tax years beginning after 1999, 60% for tax years beginning after 2001 and 65% for tax years beginning after 2003. The NOL carryforward period was increased from five years to 10 years for tax years beginning after 1999.

* District of Columbia 

A court of appeals en banc ruling(44) upheld original appeals court rulings that (1) corporations are entitled to NOL deductions on D.C. corporate returns filed on a separate-company basis, even if those losses were fully offset by the income of affiliated corporations on a prior Federal consolidated return and (2) unincorporated businesses are entitled to NOL deductions.

For many years, the District has maintained that corporations were entitled to NOLs only if that deduction was taken on that corporation's Federal return for the same tax year. In addition, the District has historically held that unincorporated businesses, although subject to the unincorporated business franchise tax, were not entitled to NOL deductions. This ruling rejects those interpretations.

* Missouri

The Administrative Hearing Commission ruled that a corporation could carry over NOLs from subsidiaries that merged into it and liquidated, even though the subsidiaries were not subject to Missouri tax when the losses were generated.(45) The Commission found that a regulation providing that an NOL from a year in which the corporation was not subject to Missouri tax may not be used to determine state taxable income was not supported by the law and was inconsistent with Mo. Rev. Stat. [sections] 143.431, which requires Federal taxable income to be the starting point for determining Missouri taxable income.

Other Modifications

* Alabama

An ALJ held that a corporation's investments in eight subsidiaries were business assets for purposes of the foreign corporation interest expense deduction.(46) Alabama Multistate Tax Commission Reg. 810-27-1-4-.01(d)(1) (formerly Reg. 810-3-31-.02(a)(5)(I)) provided that a foreign corporation's "interest expense shall be prorated to nonbusiness assets by multiplying that interest expense by the ratio of average costs of the nonbusiness assets to the average cost of the total assets." The ALJ held that, if an asset produces apportionable business income, it should be treated as a business asset and vice versa (i.e., if dividends paid by a subsidiary to a parent constitute business income, either because the subsidiary is unitary with the parent or it serves an operational function in the parent's business, the underlying stock is a business asset of the parent). The ALJ relied on proof that the taxpayer filed returns in six other states that reported the eight subsidiaries as part of its unitary business operations. According to the ALJ:

[T]he unitary business concept does not vary from state to state. A subsidiary cannot be unitary with its parent in one state, and not unitary in another state. Consequently, having reported as a fact under penalty of perjury in at least six states that the eight subsidiaries were part of its unitary business, the Taxpayer cannot now argue that the subsidiaries were not unitary for the sole purpose of reducing its Alabama liability.

Because the subsidiaries were unitary with the parent, they had to be treated as business assets.

* California

The U.S. Supreme Court unanimously reversed a state court decision. In Hunt-Wesson Inc. v. FTB,(47) the Court held that the state's interest-deduction offset provision is not a reasonable allocation of expenses to income and is an impermissible taxation of income outside the state's jurisdiction.

* Connecticut

The superior court ruled the total commission expenses paid to a corporation's wholly owned foreign sales corporation were deductible in computing the corporation business tax.(48)

* Iowa

The DOR amended Rule 701-54.3(422) to conform it to the U.S. Supreme Court's decision in Hunt-Wesson, Inc.

* Michigan

The tax tribunal held that a taxpayer's capital gain on the sale of its subsidiaries was subject to SBT.(49) In 1992, Amoco Production Company (Amoco) sold two of its wholly owned foreign subsidiaries (Amoco Trinidad and Amoco Argentina) to an affiliated corporation and recognized a significant capital gain. Amoco and the affiliated corporation filed a consolidated return for Federal income tax purposes and properly eliminated the gain in the consolidation. Amoco filed a separate return for SBT purposes. Before the tax tribunal, Amoco argued that the capital gain should be deducted from its tax base, for three reasons: (1) the sale was excludible as a casual sale; (2) the payment of the oil and gas severance tax precludes payment of any other tax in Michigan; and (3) the inclusion of the capital gain violates Federal Due Process. The tribunal rejected all three of Amoco's arguments; it held that the entire gain had to be included in Amoco's tax base.

* Michigan

The court of appeals ruled that a corporation may not deduct from its SBT base income from the sale of its assets, because the casual transaction exclusion is not available to corporations.(50)

* Minnesota

Corporations are required to make accelerated cost recovery system (ACRS) adjustments for property placed into service before 1987. After the 2000 tax year, such adjustments are no longer required.(51) Any remaining disallowed ACRS can be deducted on the 2001 tax return.

* New York

An ALJ ruled that an alien corporation operating in the state must include foreign-source income on its franchise tax return, even though such income was not included on its Federal return.(52)

* Virginia

The Department ruled that a corporation cannot subtract salary and wage expenses disallowed as a deduction in determining Federal taxable income because the taxpayer used a Federal empowerment zone employment credit (EZEC).(53) IRC Sec. 280C(a) disallows the deduction of salary and wage expenses to the extent used to compute an EZEC under IRC Sec. 1396.

Although Virginia law specifically allows a subtraction to taxpayers for wages and salaries disallowed because of the Federal work opportunity tax credit, it contains no similar provision for the EZEC. Accordingly, a Virginia income tax deduction for salary and wage expense disallowed in computing Federal taxable income because of a taxpayer's election to use an EZEC is not allowable as a subtraction in the computation of Virginia taxable income.

(1) Tyson Foods, Inc. v. Ill. Dep't of Rev. (DOR), Ill. App. Ct., No. 1-98-1476 (12/28/99).

(2) Ill DOR, IT 00-0002-GIL (1/3/00).

(3) Texas Comptroller of Public Accts., Hearing No. 36,590 (1/20/00).

(4) Va. Ruling of Comm'r, P.D. 99-278 (10/14/99).

(5) SYL, Inc. v. Comptroller of the Treasury, Cir. Ct. for Baltimore City, No. 24-C-99-002389 AA (3/17/00), aff'g Md. Tax Ct., No. C-96-0154-01 (4/26/99), and Crown Cork & Seal (Delaware), Inc. v. Comptroller of the Treasury, Cir. Ct. for Baltimore City, No. 24-C-99-002388 AA (3/17/00), aff'g Md. Tax Ct., No. C-97-0028-01 (4/26/99).

(6) In the Matter of the Protest of Kmart Properties, Inc., NM Tax'n and Rev. Dep't, No. 00-04 (2/1/00).

(7) NC Sec'y of Rev., Dec. No. 97-990 (9/19/00).

(8) Borden Chemicals and Plastics, L.P. v. Ken Zehnder, Dir. of DOR, Ill. App. Ct., 1st Dist., No. 1-98-4456 (2/14/00).

(9) Adirondack Truck Leasing Inc., Ill. DOR, Admin. Hearing Dec. No. IT 00-6 (8/25/00).

(10) MCI Int'l Telecomms. Corp. v. Comptroller of the Treasury, Cir. Ct. for Baltimore City, No. 24-C-99-002387 AA (3/17/00), aff'g Md. Tax Ct., No. C-96-0028-01 (4/26/00).

(11) Shaklee Corp. v. Comm'r of Rev., Mass. ATB, Nos. F245496 and F245497 (2/7/00).

(12) Jafra Cosmetics, Inc. v. Comm'r of Rev., Mass. ATB, No. 178135 (11/22/99).

(13) 1999 PA 115.

(14) RAB 1999-10 (1/21/00).

(15) RAB 1999-9 (1/21/00).

(16) RAB 2000-5 (8/17/00).

(17) RAB 1998-1 (2/24/98).

(18) Ellsworth Co., Inc., NYC Tax Apps. Trib'l, No. TAT(H) 92-158(GC) (7/21/00).

(19) Mazie Corp., NYC Tax Apps. Trib'l, No. TAT(H) 92-353(GC) (7/21/00).

(20) UCOM, Inc. v. Roger W. Tracy, Comm'r of Ohio, Ohio Bd. of Tax Apps., No. 97-K-880 (5/26/00).

(21) J.C. Penney Nat'l Bank v. Ruth Johnson, Comm'r of Rev., State of Tenn., Tenn. Ct. of Apps., Appeal No. 00497-COA-R3-CV (12/17/99), rev'g Davidson Chancery Dkt. No. 96-276-I (10/16/98).

(22) Carole K. Rylander v. Bandag Licensing Corp., Texas Third Ct. of Apps., No. 03-99-00427-CV (5/11/00).

(23) NYS Dep't of Tax'n and Fin., George R. Funaro & Co., TSB-A-00(13)C (7/11/00).

(24) Allied-Signal, Inc., 504 US 768 (1992).

(25) Ex Parte Uniroyal Tire Co., Ala. Sup. Ct., No. 1981928 (8/4/00), rev'g and rem'g sub nom. Uniroyal Tire Co., Inc. v. State DOR, Ala. Ct. of Civil Apps., No. 2971007 (5/28/99).

(26) Danov Corp. v. State of Ala., Dkt. No. 97-283 (12/22/00).

(27) App. of Cons. Freightways, Inc., Cal. SBE, No. 98A-0499 (9/14/00).

(28) Home Interiors and Gifts, Inc. v. DOR, Ill. App. Ct., 1st Dist., No. 1-99-1953 (9/29/00).

(29) In the Matter of the Appeal of the Kroger Co., Kan. Sup. Ct., No. 83,927 (11/3/00).

(30) Hoechst Celanese Corp. v. Comm'r of Rev., Mass. ATB, No. 194694 (6/30/00).

(31) Polaroid Corp. v. Muriel K. Offerman, 349 NC 290 (1998), cert. den.

(32) Union Carbide Corp. v. Muriel K. Offerman, NC Ct. of Apps., No. COA97-956 (4/6/99).

(33) Union Carbide Corp. v. Muriel K. Offerman, NC Sup. Ct., No. 453A98-2 (2/4/00).

(34) Lenox, Inc. v. Muriel K. Offerman, NC Ct. of Apps., No. COA99-1267 (12/5/00).

(35) Willamette Industries Inc. v. DOR, Ore. Sup. Ct., No. SC S46137 (11/17/00).

(36) Pennzoil Co. v. DOR, Ore. Tax Ct., No. 4301 (3/17/00).

(37) Sandoz Agro, Inc. v. DOR, Ore. Tax Magistrate Div., No. 990107D (2/1/00).

(38) Ceridian Corp. v. Franchise Tax Board (FTB), Cal. Ct. of App., Dkt. No. A084298 (12/21/00).

(39) See, e.g., Appeal of Sundstrand, Cal. SBE, No. 99A-0375.

(40) Bernard Egan & Co. v. Florida DOR, Fla. Dist. Ct. of App., No. 4D99-0233 (8/16/00).

(41) In the Matter of the Appeal of Morton Thiokol, Inc., 864 P2d 1175 (1993).

(42) Kraft Gen'l Foods, Inc. v. Iowa Dep't of Rev. and Fin., 505 US 71 (1992).

(43) Emerson Electric Co. v. Tracy, Ohio Sup. Ct., No. 99-1879 (10/4/00).

(44) School Street Associates LP v. District of Columbia, DC Ct. of Apps., Nos. 97-TX-1442 and 97-TX-2001 (1/4/01).

(45) Cooper Industries, Inc., Md. Admin. Hearing Comm., No. 98-2920 RI (8/9/00).

(46) Vulcan Materials Co. v. DOR, ALJ Div., No. 98-157 (8/3/00).

(47) Hunt-Wesson Inc. v. FTB, 112 Sup. Ct. 1022 (2000), rev'g and rem'g Cal. Ct. of App., 1st App. Dist., Div. Three, No. A079969 (12/11/98).

(48) Eastman Kodak Co. v. Comm'r of Rev. Svcs., Ct. Sup'r Ct., No. CV 98 0492598S (5/26/00).

(49) Amoco Prod. Co. v. Dep't of Treasury, Mich. Tax Trib'l, No. 249475 (3/27/00).

(50) Guardian Photo, Inc. v. Dep't of Treasury, Mich. Ct. of Apps., No. 218503 (11/14/00).

(51) Minn. Omnibus Tax Bill, Ch. 490, Laws 2000.

(52) Schlumberger Ltd., NY Div. of Tax. Apps., ALJ Unit, DTA No. 816620 (4/13/00).

(53) Va. Ruling of Comm'r, P.D. 00-166 (9/6/00).

For more information about this article, contact Ms. Boucher at [e-mail].

Karen J. Boucher, CPA Principal Arthur Andersen LLP Milwaukee, WI