Transcript Combined Returns

Combined Reporting
Cindy Avrette
Revenue Laws Study Committee
December 12, 2006
Combined Reporting
 WHAT IS IT?
It is a method of calculating the income of a group of
affiliated corporations for tax purposes
 HOW?
It looks beyond the legal structure of separate
incorporations to determine whether two or more
affiliated corporations are engaged in a single unitary
business
 WHY?
To ensure the income of a multiple entity unitary
business computed and apportioned in the same manner
as a single corporate business
Advantages of Combined
Reporting
 Comprehensive way to nullify income
shifting strategies
 Provides a more level playing field
 Means to modernize state tax code to
adapt to the growth of multi-state
corporations – Recommended by
Governor’s Commission to Modernize
State Finances in 2002
What is Combined Reporting?
 An accounting of the total income
derived by a group of affiliated
corporations from the operation of its
unitary business.
 A unitary business is a common
enterprise engaged in by one or more
members of a group of affiliated
entities.
What is a Combined Report?
 It is NOT a tax return.
 It is an accounting document
prepared on behalf of a group of
affiliated corporations engaged in a
unitary business.
 Only those members of a unitary
group that have nexus with NC pay
corporate income tax to NC – Based
on the combined group’s net income
Questions to Answer
 Mandatory v. voluntary
 Definitions
 Affiliated corporations
 Unitary business
 Type of Combined Reporting
 Worldwide
 Water’s Edge
 Method of Apportionment
Mandatory v. voluntary
 Elective combined reporting would do
nothing to reduce the tax planning
opportunities – one of the primary
benefits of combined reporting
Questions to Answer
 Mandatory v. voluntary
 Definitions
 Affiliated corporations
 Unitary business
 Type of Combined Reporting
 Worldwide
 Water’s Edge
 Method of Apportionment
Who must file a combined
report?
 Corporations
 that are affiliated
 and that are engaged in the same
unitary business.
Corporations ...
 All corporations that are subject to
corporate income tax or would be
subject to the tax if doing business in
this State
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Insurance companies – No.
Financial institutions. – Yes.
REITs and RICs. – Yes.
Non-US corporations. – Yes, if worldwide
combined reporting
… that are affiliated …
 More than 50% common stock
ownership
 Familiar rule with wide spread
acceptance
and engaged in the same unitary
business.
 No universally accepted definition
 Vertically or horizontally integrated
 Established judicial tests
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Unity of ownership, use, and operation
Contribution or dependency
Centralized management
Functional integration
Economies of scale
Flow of value
Multistate Tax Commission (MTC)
A that is made up either single economic
enterprise of separate parts of a single
business entity or of a commonly controlled
group of business entities that are
sufficiently interdependent, integrated and
interrelated through their activities so as to
provide a synergy and mutual benefit that
produces a sharing or exchange of value
among them and a significant flow of value
to the separate parts.
Center for Policy Alternatives
A group of corporations that are related
through common ownership, and, by a
preponderance of the evidence, are
economically interdependent with one
another as demonstrated by the following
factors:
a. Centralized management;
b. Functional integration; and
c. Economies of scale.
Alaska
 A business is unitary if the entity or entities
involved are owned, centrally managed, or
controlled, directly or indirectly, under one
common direction which can be formal or
informal, direct or indirect, or if the
operation of the portion of the business
done within the state is dependent upon or
contributes to the operation of the business
outside the state.
California
 Does not have a statutory definition.
 Its Code of Regulations provides
guidelines on what a unitary business
is.
Colorado
 Unique attempt to provide a bright-line test
 Must find at least three of the following six
factors are present for the current year and
the two preceding tax years:
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Intercompany sales or leases
Services provided by one for others
Long-term debt
Use of proprietary materials owned by another
Common corporate control
Common corporate management
Illinois
 A group of persons related through
common ownership whose business
activities are integrated with,
dependent upon and contribute to
each other.
Hawaii
 Business carried on by a group of
entities that includes the taxpayer
where there are flows of value among
the entities resulting from (1)
functional integration, (2)
centralization of management, or (3)
economies of scale.
Minnesota
 Business activities or operations
which result in a flow of value
between them. … Flow of value is
determined by reviewing the totality
of facts and circumstances of
business activities and operations.
Montana
 The business operations conducted by
the corporations in the affiliated
group are interrelated or
interdependent to the extent that the
net income of one corporation cannot
reasonably be determined without
reference to the operation conducted
by the other corporation.
Nebraska
 A business that is conducted as a
single economic unit by one or more
corporations with common ownership
and shall include all activities in
different lines of business that
contribute to the single economic
unit.
New Hampshire and Vermont
 One or more related business
organizations engaged in business
activity both within and without this
state among which there exists a
unity of ownership, operation, and
use; or an interdependence in their
functions.
Oregon
 A corporation or group of corporations
engaged in business activities that
constitute a single trade or business.
 A single trade or business is a
business enterprise in which there
exists directly or indirectly between
the members … a sharing or
exchange of values …
Utah
 A group of corporations that are related
through common ownership and by a
preponderance of the evidence as
determined by a court of competent
jurisdiction or the commission, are
economically interdependent with one
another as demonstrated by the following
factors:
 Centralized management
 Functional integration
 Economies of scale
Definition of unitary business
 Different definitions – Same concept
 Proposal: Broad definition
 Less opportunity for manipulation
 Lower compliance costs
Questions to Answer
 Mandatory v. voluntary
 Definitions
 Affiliated corporations
 Unitary business
 Type of Combined Reporting
 Worldwide
 Water’s Edge
 Method of Apportionment
Worldwide v. Water’s Edge
 Two general approaches on how to
deal with a unitary group member
that is incorporated in a foreign
country
 Prevailing position is worldwide
combination with a water’s edge
election
Worldwide combination
 Consistent with concept that a unitary
business should be taxed without regard to
its organizational structure.
 Constitutionality valid.
 Controversial.
 Distortions in property and payroll factors.
 Difficulty of accounting and audit.
 Business community does not favor it.
 No major industrialized country requires it
for income tax purposes.
Water’s edge combination
 Exclude 80/20 corporations – A
corporation whose business activity
outside the US is 80% or more of the
corporation’s total business activity.
 Avoids the compliance burden of a
worldwide combination.
Worldwide Combination with
Water’s Edge Election
 Water’s edge group includes:
 U.S. corporations
 Non-U.S corporations that do not meet
the 80/20 test
 Corporations doing business in tax-haven
countries
 Related intangible holding companies
Water’s Edge Election
 Election must be in writing
 Election binding for an initial period of
time (MTC = 10 yrs)
 Election automatically extended
unless notice given of intent not to
renew before the end of the last two
years of the election period
 If election terminated, cannot be
renewed for minimum period of time
Questions to Answer
 Mandatory v. voluntary
 Definitions
 Affiliated corporations
 Unitary business
 Type of Combined Reporting
 Worldwide
 Water’s Edge
 Method of Apportionment
Apportionment Formula
 Prevent income from being taxed
twice
 Three factor formula
 Property in NC/Total property
 Payroll in NC/Total payroll
 Sales in NC/Total sales
 Property + Payroll + 2(Sales)/4 =
Apportionment Percentage
Apportionment of Income –
Single entity reporting
 Calculate apportionable taxable income
under NC law
 Calculate apportionment percentage using
the apportionment formula
(Property + Payroll + 2(Sales)/4)
 Multiply apportionable taxable income by
apportionment percentage to determine
apportionable taxable income
 Apportionable income + Nonapportionable
income allocated to state = taxable income
 Apply the tax rate to taxable income
Apportionment of Income –
Combined Reporting
 Calculate apportionable taxable income under NC law
for entire combined group (subtracting income
from inter-company transactions)
 Calculate apportionment percentage by applying the
apportionment formula using the aggregate factors
of the combined group (payroll, property, sales)
 Multiply apportionable taxable income for entire
combined group by apportionment percentage to
determine the State net income of the unitary
business
Taxation of individual members
of unitary group
 Members calculate own apportionment
percentage based upon their payroll,
property, sales
 Apply apportionment percentage to the
combined group’s net taxable income = net
taxable income of taxpayer from unitary
business
 Taxpayer’s NC taxable income = this
amount + apportionable income derived
from other business activities +
nonapportionable income allocated to NC
Apportionment of Income –
Combined Reporting
 Calculate apportionment percentage
by applying the apportionment
formula using the aggregate factors
of the combined group (payroll,
property, sales)
 Property in NC/Aggregate property
 Payroll in NC/Aggregate payroll
 Sales in NC/Aggregate sales X 2
Method of Apportionment:
“… in North Carolina”
 Finnigan: include the property, payroll, and sales
of those members in the State, regardless of
nexus
 Prevents tax planning techniques for isolating
sales in non-nexus affiliates
 Constitutionality unclear/Litigation more likely
 Joyce: include only the property, payroll, and
sales of those members that have nexus with the
State in the numerator
 Most accepted method
 Tax avoidance strategies exist
MTC Recommendation
 Joyce method of apportionment
 Adopt a throwback provision
 Sales are sourced to the destination
state
 Throw-back causes the sales to be
sourced to the state from which the
property was shipped if the destination
state does not impose income tax
 Provision resolves some of the tax
avoidance strategies
Proposal …
 Mandatory combined returns
 Definitions
 Affiliated corporations – 50%
 Unitary business – Broad
 Type of Combined Reporting
 Worldwide with Water’s Edge Election
 Method of Apportionment
 Joyce method
 Throw-back provision