On Feb. 25, 2021, the Wisconsin Court of Appeals affirmed the rulings of the Wisconsin Circuit Court of Dane County and the Wisconsin Tax Appeals Commission that distributions from limited liability partnerships (LLPs) electing to be federally taxed as corporations are treated as dividends for purposes of Wisconsin’s dividends received deduction (DRD).1
The Wisconsin Department of Revenue sought to disallow the Wisconsin DRD, arguing that such distributions were not made with respect to the company’s “common stock.” The Court of Appeals upheld the Circuit Court’s ruling, concluding that the Department’s position was contrary to administrative guidance published by the Department and in effect during the audit years. By upholding the Circuit Court’s ruling in favor of the taxpayer’s motion for summary judgment, the Court of Appeals provides further guidance and clarity to corporate taxpayers that prepare their tax returns in accordance with published guidance by the Department. However, by failing to address the underlying statutory interpretation issue, the Court of Appeals left corporate taxpayers to rely on the Circuit Court’s less precedential analysis of this issue.
The taxpayer, Deere & Company (Parent), is a Delaware corporation that manufactures and markets agricultural equipment, consumer/commercial lawn equipment, engines and drive trains used in heavy equipment. During the tax years subject to audit (the fiscal years ended October 2013 through October 2015), Parent owned the sole membership interest of John Deere Holding, LLC (JDH-US), which was treated as a disregarded entity for federal and Wisconsin income and franchise tax purposes.
In 2011, Parent and JDH-US formed John Deere Holding LLC 1 S.C.S. (JDH-Lux) as a Luxembourg limited partnership. Through the partnership agreement, JDH-Lux issued all of its partnership interests to Parent and JDH-US. Parent filed federal Form 8832, Entity Classification Election, with the Internal Revenue Service to treat JDH-Lux as an association taxable as a corporation for federal income tax purposes, and declared on its federal Forms 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, during the audit period that its ownership interest in JDH-Lux was a capital interest in a partnership.
During the tax years subject to audit, Parent and JDH-US received distributions of cash from JDH-Lux. Parent filed these distributions from JDH-Lux as dividend income on its federal consolidated income tax returns and Wisconsin combined franchise tax returns for these tax years. Because JDH-US was a disregarded entity for federal income and Wisconsin income and franchise tax purposes, Parent also included the distributions that JDH-US received from JDH-Lux as dividend income.
On Parent’s Wisconsin combined franchise tax returns filed during the tax years subject to audit, it utilized a Wisconsin DRD pursuant to Wis. Stat. Sec. 71.26(3)(j) for the full amount of the distributions from JDH-Lux, claiming such distributions were from common stock.2 In 2017, the Department issued Parent an assessment for additional tax and interest, asserting that the distributions from JDH-Lux did not qualify for the Wisconsin DRD because its ownership interests did not constitute “common stock” under Wis. Stat. Sec. 71.26(3)(j). After the Department denied Parent’s Petition for Redetermination, Parent timely filed its Petition for Review with the Commission. On Aug. 21, 2019, the Commission ruled in favor of Parent that the distributions from JDH-Lux qualified for the Wisconsin DRD.3 The Department appealed this decision to the Wisconsin Circuit Court, which ruled in favor of Parent on March 9, 2020.4 Subsequently, the Department appealed to the Wisconsin Court of Appeals.
Application of DRD
Before the Commission, Parent asserted that by electing to “check-the-box” to be treated as an association taxable as a corporation for federal and Wisconsin tax purposes, JDH-Lux’s ownership interest was converted to common stock under Treas. Reg. Sec. 301.7701-3(g)(1)(i).5 As a result, JDH-Lux was treated as a corporation for tax purposes under Internal Revenue Code (IRC) Sec. 7701. In its ruling, the Commission agreed with Parent on this issue. The Commission further noted that, consistent with the Department’s own guidance on the treatment of limited liability companies (LLCs) in Publication (Pub.) 119,6 the ownership interests of an LLP that makes the federal check-the-box election are to be treated in the same manner as stock.
At the Circuit Court, the Department disagreed with the Commission’s conclusions, arguing that since JDH-Lux, as an LLP, did not issue common stock, JDH-Lux’s distributions were made with respect to Parent’s partnership interests rather than dividends from stock. Alternatively, the Department argued that Chapter 71 of the Wisconsin Code7 does not contain any statutory language allowing distributions from partnerships to be treated as dividends. The Circuit Court upheld the Commission’s ruling, concluding that the cash dividend distributions by JDH-Lux were made with regard to common stock under IRC Sec. 7701 and Treas. Reg. Sec. 301.7701-3(g)(1)(i), and thus qualified for the Wisconsin DRD.
Before the Court of Appeals, the Wisconsin Department of Revenue challenged the following two holdings of both the Circuit Court and the Commission:
- Under a plain-language reading of Wisconsin’s DRD statute,8 JDH-Lux qualified as a corporation such that its distributions to Parent qualified for the Wisconsin DRD; and
- Regardless of the proper interpretation of the Wisconsin DRD statute, the Department was precluded under Wis. Stat. Sec. 73.16(2)(a) from disallowing Parent’s Wisconsin DRD, because to do so would be contrary to guidance published by the Department during the years under audit (the “contrary-to-guidance” issue).9
The Court of Appeals limited its analysis to the contrary-to-guidance issue, concluding that since this issue alone was dispositive, it did not need to address the statutory interpretation issue. Under Wis. Stat. Sec. 73.16(2)(a),
Before the Commission, the Department’s “position” was that distributions from JDH-Lux did not qualify for the Wisconsin DRD because JDH-Lux was not a corporation, and thus the distributions were not “dividends . . . with respect to its common stock” as required under Wis. Stat. Sec. 71.26(3)(j). The Commission noted that under Section IX of Pub. 119 as published during the tax years under audit, the Department stated that if “an LLC is classified as a corporation, an LLC interest is treated in the same manner as stock.” Holding that this guidance for LLCs also applied to LLPs, the Commission concluded that the Department’s position was contrary to this guidance, and thus could not be sustained under Wis. Stat. Sec. 73.16(2)(a).
In its appeal to the Court of Appeals, the Department advanced four arguments to support its contention that the guidance in Pub. 119 was not contrary to its position disallowing the Wisconsin DRD for JDH-Lux’s distributions:
- Pub. 119 pertains to the taxation of LLCs, not limited partnerships;
- Pub. 119 did not specifically address the Wisconsin DRD;
- The guidance at issue in Pub. 119 only addresses the tax treatment of the sale of ownership interests in an LLC electing to be taxed as a corporation, and not the tax treatment of distributions related to such ownership interests; and
- The guidance at issue in Pub. 119 pertaining to LLC interests being “treated in the same manner as stock” sought to draw a meaningful distinction between treating LLC interests “as if they were stock,” and such interests “actually becoming stock.”
In its decision, the Court of Appeals rejected each of these four arguments. Specifically, the Court of Appeals held that:
- The Department’s first argument failed because the Department’s position was that distributions from any non-corporate entity (not just limited partnerships) should not qualify for the Wisconsin DRD; thus, focusing on a distinction between LLCs and limited partnerships was too narrow relative to the Department’s actual position.
- The Department’s second argument did not address how the guidance treating one type of non-corporate ownership interest as stock does not conflict with the Department’s current position, even though such guidance does not expressly reference the Wisconsin DRD.
- The Department’s third argument offered too narrow of a reading of the guidance in Pub. 119. As argued, such an interpretation requires the reader to ignore the portion of Section IX of Pub. 119 referencing the treatment of LLCs electing to be taxed as corporations.
- The Department’s fourth argument failed to properly reconcile the guidance in Pub. 119 with the “treatment-for-tax-purposes legal fiction regarding ‘stock’” under Wis. Stat. Secs. 71.22(1k) and 71.26(3)(j).
Having rejected all four of the Department’s arguments on the contrary-to-guidance issue, the Court of Appeals affirmed the ruling of the Circuit Court, concluding that the Department failed “to develop a supported argument that it could contradict its own guidance before the commission despite the prohibition in Wis. Stat. Sec. 73.16(2)(a).”
The Court of Appeals, in upholding the rulings of both the Commission and the Circuit Court, rejected the Department’s arguments regarding the applicability of its published guidance under Pub. 119 to the Wisconsin DRD at issue in this case. As a result, the Court of Appeals concluded that JDH-Lux was a corporation such that its distributions to Parent qualified for the Wisconsin DRD.
It is important to note that under Wisconsin law, the determinations and audit adjustments made by the Department are presumed to be accurate, and the burden rests with the taxpayer to demonstrate by clear and convincing evidence that the Department erred.10 Therefore, it is telling that the Commission, the Circuit Court, and now the Court of Appeals have all ruled in Parent’s favor, as it demonstrates the level of scrutiny that Parent satisfied to allow all three of these forums to conclude that the Department’s position regarding the Wisconsin DRD was erroneous.
The Circuit Court’s decision provided taxpayers with additional clarity regarding the Wisconsin taxation of cash distributions from foreign subsidiaries following the IRC Sec. 965 repatriation tax paid on their 2017 federal income tax return. Wisconsin generally does not conform to IRC Sec. 965 or Subpart F of the IRC. Thus, foreign dividends are only taxable in Wisconsin when cash or other property is actually distributed. Prior to the Commission’s decision, many taxpayers may have assumed that the Wisconsin DRD would apply to cash distributions repatriated after 2017 by foreign check-the-box subsidiaries to their corporate owners.
Unfortunately, the Court of Appeals chose to solely analyze the contrary-to-guidance issue as it applies to the Wisconsin DRD, while not addressing the statutory construction issue. This may have been the case in part for a procedural reason. When a Circuit Court order affirms or reverses a Commission decision, the Court of Appeals is compelled by case law to review the Commission’s decision, not the Circuit Court’s decision which contained significant statutory construction analysis.11 Moreover, the Court of Appeals may not have wanted to address the statutory construction issue because it had already found for the taxpayer on other grounds, and because the potential remains for additional controversies that it may have to adjudicate in the future, particularly with respect to the treatment of distributions that were subject to the IRC Sec. 965 repatriation tax.
The pertinent language in Pub. 119 as published from 2013 to 2015 was deleted when the Department revised Pub. 119 in June 2019. Thus, one open question to consider is the extent to which the Court of Appeals’ analysis and holding will apply for tax returns filed, or for tax years ending after the date on which the revised Pub. 119 was published. As the Wisconsin DRD statutory language under Wis. Stat. Sec. 71.26(3)(j) remains unchanged for subsequent tax years, taxpayers did not have the opportunity to receive further clarifying guidance that would be applicable for tax years after the Department’s changes to Pub. 119. Such guidance is particularly needed for corporate taxpayers repatriating amounts previously taxed federally under IRC Sec. 965 in tax years after the Department updated Pub. 119. The Court of Appeals did not overturn the Circuit Court’s holding on the statutory interpretation issue. Therefore, while less precedential than a Court of Appeals opinion, corporate taxpayers can still rely upon the Circuit Court’s analysis and holding on the statutory construction issue for tax years following the Department’s changes to Pub. 119.
With these decisions, taxpayers now have additional guidance that such distributions would qualify for the Wisconsin DRD (assuming that the ownership requirements under Wis. Stat. Sec. 71.26(3)(j) are also satisfied). It is not clear yet if the Department will appeal this decision to the Wisconsin Supreme Court, which would have discretion to either hear the case or deny such appeal. If the Department proceeds, such an appeal is due within 30 days of the Court of Appeals’ decision.
Corporate taxpayers currently under audit in Wisconsin should discuss this decision with their advisors and auditors to the extent that the Department is seeking to limit the application of the Wisconsin DRD. Furthermore, to the extent that prior-year Wisconsin corporate income tax returns were filed without utilizing the Wisconsin DRD for dividend distributions from partnerships electing to be taxed as a corporation (perhaps as a result of a previous Wisconsin audit), such taxpayers should consider filing an amended return to utilize the Wisconsin DRD.
1 Wisconsin Department of Revenue v. Deere & Co., Wisconsin Court of Appeals (District IV), Appeal No. 2020AP726, Feb. 25, 2021.
2 The statute provides in pertinent part that “corporations may deduct from income dividends received from a corporation with respect to its common stock if the corporation receiving the dividends owns, directly or indirectly, during the entire taxable year at least 70 percent of the total combined voting stock of the payor corporation.” WIS. STAT. § 71.26(3)(j) (emphasis added).
3 Wisconsin Tax Appeals Commission, Dkt. No. 18-I-135, Aug. 21, 2019.
4 Wisconsin Circuit Court (Dane County), Case No. 2019CV002596, March 9, 2020. For a discussion of this decision, see GT SALT Alert: Wisconsin clarifies application of state DRD.
5 Treas. Reg. § 301.7701-3(g)(1)(i) states the following regarding the deemed treatment of a taxpayer’s election to treat a partnership as an association subject to tax as a corporation: “The partnership contributes all of its assets and liabilities to the association (taxable as a corporation) in exchange for stock in the association, and immediately thereafter, the partnership liquidates by distributing the stock of the association to the partners.”
6 Publication 119, Wisconsin Department of Revenue, revised June 2019.
7 This chapter provides the income and franchise tax statutes.
8 WIS. STAT. § 71.26(3)(j).
9 See Publication 119, as revised and published during the audit period (June 2019). The Court of Appeals noted that the version of Pub. 119 as revised in June 2019 withdraws the language at issue, which pertained to the treatment of LLC interests as stock when the LLC has elected to be treated as a corporation for tax purposes; see https://www.revenue.wi.gov/DOR%20Publications/pb119.pdf.
10 Puissant v. Wisconsin Department of Revenue, Wisconsin Tax Appeals Commission, Dkt. No. I-9275, July 5, 1984.
11 Wisconsin Department of Revenue v. Microsoft Corp. 936 N.W. 2d 160 (Wis. Ct. App. 2019).
Chris Martin is a Tax partner in Grant Thornton LLP’s Tax Reporting and Advisory practice. He also serves as the office managing partner for the firm’s Boston office.
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Jamie C. Yesnowitz
Jamie Yesnowitz, principal serving as the State and Local Tax (SALT) leader within Grant Thornton's Washington National Tax Office, is a national technical resource for Grant Thornton's SALT practice. He has 22 years of broad-based SALT consulting experience at the national and practice office levels in large public accounting firms.
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