Many of the SALT developments occurring over the past month addressed combined reporting issues, group composition, and adjustments that a state tax authority is allowed to make to more properly reflect a taxpayer’s income reportable to such state. The District of Columbia budget is poised to adopt the Finnigan method of apportionment for combined reporting and raise the sales tax rate. Also, the Minnesota Tax Court approved the Commissioner of Revenue’s use of alternative apportionment for income from a major manufacturer’s contracts to manage currency fluctuations. The New Mexico Court of Appeals interpreted the state’s “unitary corporation” definition and held that foreign subsidiaries are expressly excluded. North Carolina enacted legislation that repeals the transaction threshold of the sales tax economic nexus standard. Finally, the South Carolina Administrative Law Court held that the Department of Revenue was justified in requiring combined unitary reporting to properly reflect the taxpayer’s income earned in the state. The July issue of State and Local Thinking examines each of these developments.
District of Columbia budget adopts Finnigan, raises sales tax
On July 15, 2024, the District of Columbia enacted the Fiscal Year 2025 Budget Support Emergency Act of 2024, B25-875, without the signature of Mayor Muriel Bowser. This emergency legislation expires Oct. 13, 2024. B25-875 adopts the Finnigan method of apportionment for combined reporting, raises the sales tax rate, and makes some noteworthy property tax changes.
For tax years beginning after Dec. 31, 2025, the District of Columbia changes from the Joyce to the Finnigan method of apportionment for combined reporting. Specifically, a combined group of entities will be treated as one taxpayer for purposes of sourcing unitary receipts, and the apportionment factor attributes in the numerator will be derived from all members of the combined group, regardless of whether a specific entity in the group has nexus with the District. Also, the statute imposing a 3% tax on the capital gain from the sale or exchange of an investment in a Qualified High Technology Company in lieu of an income tax is repealed.
Under current law, individuals, estates and trusts are not required to include interest on the obligations of the District of Columbia, a state, a U.S. territory, or any political subdivision in these jurisdictions in computing District gross income. For tax years beginning after Dec. 31, 2024, individuals, estates and trusts will be required to include interest on the obligations of a state or any political subdivision in the computation of District gross income, but an exemption will continue to be provided for interest on obligations of the District or bonds issued by DC Water, the Washington Metropolitan Area Transit Authority, and the District of Columbia Housing Finance Agency.
The sales tax rate imposed on gross receipts from sales or exchanges of tangible personal property and services will increase from 6% to 6.5% beginning Oct. 1, 2025, and 7% beginning Oct. 1, 2026.
The legislation also contains commercial and residential property tax provisions. The Central Washington Activation Program (termed the Office-to-Anything Program) provides a 15-year property tax freeze for converting certain office space to new, activated commercial, entertainment or retail spaces. Eligible buildings for the program include the construction, alteration, or renovation of a property with a minimum of 50,000 square that results in the conversion of the property from a primary office use to a use that is not residential, or to a Trophy (Class A) office building. In addition, the District of Columbia enacted a property tax rate increase pursuant to the “Real Property Tax Emergency Amendment Act of 2024.” Beginning with the 2025 tax year, the property tax rate for certain residential property will increase from $0.85 of each $100 of taxable assessed value to $1.00 of each $100 of taxable assessed value above $2.5 million. The $2.5 million threshold will be annually adjusted for inflation.
Minnesota Tax Court affirms alternative apportionment
On June 24, 2024, in E. I. duPont de Nemours and Co. v. Commissioner of Revenue, the Minnesota Tax Court held that the Commissioner of Revenue properly used alternative apportionment for the substantial gains that an international taxpayer in the science and technology industry received from its forward exchange contracts (FECs) used to manage currency fluctuations. The court agreed with the commissioner that the standard apportionment formula did not fairly reflect all the taxable net income allocable to Minnesota. The commissioner’s alternative apportionment method of including net income from the FEC transactions instead of gross receipts fairly reflected the taxpayer’s net income in Minnesota.
The taxpayer, a major science and technology company based in Delaware, had operations in 90 countries worldwide during the 2013-2015 tax years at issue. At all relevant times, the taxpayer conducted significant international operations resulting in many currency transactions from international sales, purchases, investments, and borrowings, including numerous subsidiaries engaged in business with foreign customers. For U.S. financial reporting purposes, the taxpayer was required to report its global earnings in U.S. dollars, although it received payment for the sale of goods in foreign currencies. The taxpayer adopted a risk management policy that buys and sells FECs to offset its aggregate or net exposure from business transactions in the corresponding currency pairings. None of the FECs was conducted in Minnesota during the years at issue.
Under the standard apportionment methodology, the taxpayer included the FEC gross receipts in the sales factor denominator. The commissioner decided to use alternative apportionment and include only the net income from the FEC transactions in the apportionment formula. The taxpayer appealed the commissioner’s assessment to the Minnesota Tax Court.
The Minnesota Tax Court held that the commissioner met his burden of proving that the general apportionment method did not fairly or accurately reflect all the taxpayer’s taxable net income allocable to Minnesota. The commissioner demonstrated by substantial evidence that the FEC transactions differed materially from the taxpayer’s other business transactions. The taxpayer’s FEC activity was a legitimate business function to provide a risk management tool intended to protect the taxpayer’s other business activities and profits, rather than a profit-oriented line of business. The parties agreed that the taxpayer used FECs on a regular and recurring basis, normally with financial institutions, and gross receipts from the FECs were earned in the ordinary course of business. The court accepted the commissioner’s argument that including FEC gross receipts in the calculation of the general apportionment factor did not accurately show the taxpayer’s income arising from its taxable business activities in Minnesota. Also, the court held that including FEC gross receipts in the Minnesota apportionment factor substantially distorted the taxpayer’s income arising from taxable business activities in Minnesota because it quantitatively distorted total sales, net income, and ultimately, the apportionment factor by nearly 300%.
The commissioner also successfully proved that its alternative apportionment method fairly reflected the taxpayer’s net income in Minnesota. Under the commissioner’s methodology, the FEC gross receipts were removed from the apportionment factor and substituted with the FEC net income. Because no FEC transactions occurred in Minnesota, this alternative apportionment only affected the everywhere sales in the sales factor denominator. The court rejected the taxpayer’s proposed alternative apportionment methodology that would have included only the FEC gross receipts that related to the international transactions reported by the subsidiaries included in its Minnesota returns. This decision serves as a reminder that a taxpayer’s adherence to the statutory text when sourcing its receipts will not always be respected by a state tax authority, if it believes that the statutory approach does not reflect the amount of business activity transacted in the state.
New Mexico court holds foreign subsidiaries not unitary
The New Mexico Court of Appeals issued an opinion on June 17, 2024, for Apache Corp. v. New Mexico Taxation and Revenue Department which reversed the Department’s Administrative Hearing Officer (AHO) and held that foreign subsidiaries should not be included in the unitary group for purposes of apportioning income. According to the court, the state’s statutory definition of “unitary corporation” expressly excludes as a matter of law subsidiaries incorporated in a foreign country and not engaged in trade or business in the U.S. during the taxable year.
The taxpayer was a publicly traded multinational corporation in the business of petroleum and natural gas exploration and production with its primary offices located in Texas. Prior to 2015, the taxpayer conducted its business through domestic subsidiaries and 14 foreign subsidiaries consisting of holding companies, financing companies, and exploration and production entities incorporated and operating in various countries. The taxpayer’s foreign subsidiaries paid dividends, generated Subpart F income, or otherwise generated check-the-box income attributed to and partially reported by the taxpayer on its 2015 federal tax return. This appeal concerned only the income attributed to the taxpayer’s foreign subsidiaries. In March 2017, the Department determined that the foreign source dividends were unitary business income apportionable to the state and issued a notice of assessment for the 2015 tax year. On appeal, the AHO upheld the Department’s finding, and held that the taxpayer and its foreign subsidiaries met the definition of “unitary corporation” under N.M. Stat. Ann. Sec. 7-2A-2(Q). The AHO concluded that the dividends paid to the taxpayer by its foreign subsidiaries were subject to New Mexico corporate income tax. The taxpayer appealed this decision to the New Mexico Court of Appeals.
On appeal, the court reversed the AHO’s decision, agreeing with the taxpayer that the AHO’s construction of the statutory definition of “unitary corporation” was wrong. The court explained that the determination of whether foreign subsidiaries are included in a unitary group was a matter of first impression. The question of whether the taxpayer’s foreign dividend income was taxable by New Mexico depended on whether the taxpayer and its foreign subsidiaries could be deemed unitary corporations.
N.M. Stat. Ann. Sec. 7-2A-2(Q) defines “unitary corporation” as “two or more integrated corporations, other than any foreign corporation incorporated in a foreign country and not engaged in trade or business in the United States during the taxable year, that are owned in the amount of more than fifty percent and controlled by the same person and for which at least one” of the three unities test is met: (i) functional integration; (ii) centralized management; or (iii) economies of scale. The court noted that the statute includes two elements that must be present and a third element that is considered to be a carve-out provision. Under the two positive elements, there must be: (i) more than 50% ownership and control by the same person; and (ii) satisfaction of the three unities test. The third element expressly provides a carve-out for foreign corporations. The court concluded that the “most natural interpretation of this simple and straightforward language is that foreign subsidiaries of corporations subject to taxation in New Mexico are not to be included in the unitary corporate group for purposes of apportionment of income even if they meet the two positive qualifications.”
The court rejected the AHO’s analysis of the statute. According to the AHO, by meeting the three unities test, a foreign corporation affiliated with another corporation engaged in New Mexico business activity has itself necessarily engaged in unitary business activities in the state and the U.S. The court explained that this reading of the statute would negate the existence of the carve-out for foreign subsidiaries. In support of its conclusion, the court noted that its interpretation of the foreign subsidiary carve-out language fits the history of the U.S. Supreme Court cases concerning the state taxation of extraterritorial income and the state’s response to these cases.
North Carolina removes remote seller nexus transaction threshold
On July 1, 2024, North Carolina enacted legislation, H.B. 228, which changes the remote seller economic nexus standards for sales tax purposes. Under existing law, a retailer or marketplace facilitator was subject to North Carolina sales tax if it made remote sales sourced to the state for the previous or the current calendar year that met either of the following: (i) gross sales exceeding $100,000; or (ii) 200 or more separate transactions. This is the remote seller nexus standard that was approved by the U.S. Supreme Court in South Dakota v. Wayfair, Inc. in 2018 and subsequently adopted by many other states.
As recently amended, North Carolina has eliminated the 200 or more separate transactions threshold effective July 1, 2024. A retailer (including a marketplace facilitator) who holds a certificate of registration with the North Carolina Department of Revenue as of June 30, 2024, and is solely engaged in business in the state because the retailer exceeded the transaction threshold, may close its certificate of registration. The retailer must collect tax, file returns, and remit tax for periods ending prior to the later of: (i) July 1, 2024; or (ii) the date the retailer cancels its certificate of registration.
The legislative summary explains that this amendment is intended to reduce burdens on small business and conform to the Streamlined Sales Tax Agreement’s best practice. Less than half the states currently have the transaction-based threshold. This legislation should provide relief to remote sellers that engage in sales transactions in the state at a relatively low selling price. For example, under the original statute, a remote seller that sells 200 items in North Carolina at an average price of $20 would have a filing and remittance obligation even though it had sales of only $4,000 in the state. The amended statute will eliminate the need for remote sellers from having a registration, filing and remittance requirement if their annual sales in the state do not exceed $100,000.
South Carolina court requires combined unitary reporting
On July 12, 2024, the South Carolina Administrative Law Court (ALC) held in CarMax Auto Superstores, Inc. v. South Carolina Department of Revenue that the Department was justified in requiring combined unitary reporting to properly reflect income earned in the state. According to the ALC, the taxpayer employed a corporate structure that used transfer pricing and a partnership to allocate income to western states to distort its business activity in South Carolina and artificially lower its tax burden in the state. Requiring combination was determined to be a reasonable and equitable alternative method to correct the distortion, resulting in a fair representation of the business income in South Carolina. However, the case was remanded to the Department because it did not apply the Finnigan method to apportion the South Carolina taxable income between the two unitary corporations.
CarMax, Inc., the largest retailer of used cars in the U.S., originally had two major subsidiaries which the ALC referenced as CarMax East and CarMax West. Prior to a major corporate restructuring, CarMax East owned most of the company’s retail operations, which were in eastern states, and performed back-office support and finance functions for the company. CarMax West owned the company’s western retail stores and the company’s intellectual property (IP). In 2004, CarMax restructured its business and created a new limited liability company (LLC), CarMax Business Services (CBS), to house the headquarters, the company’s financing activities, and the IP. CBS was classified as a partnership and received contributions of property from CarMax West and CarMax East. In exchange for their contributions, CarMax West received a 93.5% ownership interest in CBS and CarMax East received a 6.5% ownership interest. CarMax East and CarMax West paid management fees to CBS for its services and IP, consisting of a flat fee charged per vehicle sold.
During the 2016-2018 audit years, due to the flow of income through the CBS partnership, CarMax East’s taxable income significantly decreased while CarMax West’s taxable income greatly increased. CarMax East generated 75% of the group’s revenue but was only attributed with 20% of the group’s taxable income. In contrast, CarMax West only produced 25% of the group’s revenue but was attributed with 80% of its taxable income. The combined effect of the management fees and the partnership distributions significantly reduced CarMax East’s South Carolina taxable income. During the three audit years, CarMax East’s South Carolina stores had a total operating profit of $90 million, but only $21 million was apportioned to the state. CBS had total income of approximately $2 billion during this period from its management fees and auto financing business.
CarMax East’s business activity in South Carolina was selling and purchasing cars through its stores as well as the sale of extended protection plans. CarMax West, which had no business activity in the state except for its 93.5% ownership interest in CBS, was taxed on CBS’s South Carolina income that flowed through the partnership. CBS’s business activity in South Carolina was related to its licensing of IP and financing income from loans originating in the state. CarMax East and CarMax West filed their tax returns using South Carolina’s standard method of separate reporting. The Department determined that separate reporting and the standard apportionment method did not fairly represent the extent of CarMax East’s business in the state. As a result, the Department concluded that combined unitary reporting was a reasonable alternative apportionment method and issued tax assessments.
On appeal, the ALC considered the South Carolina statute allowing the Department to employ alternative apportionment when the standard allocation and apportionment methods do not fairly represent the extent of the taxpayer’s business activity in the state. The ALC agreed with the Department that the statute authorized the Department to deviate from separate reporting and require combined reporting. Furthermore, the ALC held that the Department met its burden of proving that: (i) the statutory formula did not fairly represent CarMax East’s business activity in South Carolina; and (ii) the proposed alternative formula was reasonable and equitable.
The ALC determined that due to the income shifting, CarMax East’s federal taxable income and its South Carolina taxable income was “significantly and unjustifiably reduced.” According to the ALC, the management fees and partnership distributions shifted a substantial amount of income for no business reason other than tax minimization. The ALC also concluded that the structure of the CBS partnership was not justified because CarMax West’s assigned 93.5% interest in CBS was not supported by its contributions to the partnership. Also, the ALC decided that separate reporting and standard allocation and apportionment created a safe harbor for the unjustifiable income reduction.
If combined reporting was properly applied using the Finnigan method to divide the income between CarMax East and CarMax West, the ALC held that the use of combined reporting was reasonable and eliminated the distortive effect of the management fees and partnership distributions. As explained in Revenue Ruling No. 15-5, the Department applies Finnigan by including the South Carolina sales of all members (even if they do not have nexus with the state) of the combined unitary group in the sales factor numerator and the total sales everywhere for all unitary members in the denominator. The state income is then divided among the members that are taxpayers subject to tax in South Carolina. This method does not assign any of the South Carolina income to members that do not have nexus with the state. The ALC remanded the case to the Department to properly apply combined reporting by using the Finnigan method to divide the taxable income attributable to South Carolina between the two entities.
Contacts:
Jamie C. Yesnowitz
Principal, SALT Solutions – National Tax Office
Grant Thornton Advisors LLC
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.
Washington DC, Washington DC
Service Experience
- Tax
Content disclaimer
This Grant Thornton Advisors LLC content provides information and comments on current issues and developments. It is not a comprehensive analysis of the subject matter covered. It is not, and should not be construed as, accounting, legal, tax, or professional advice provided by Grant Thornton Advisors LLC. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this content.
Grant Thornton Advisors LLC and its subsidiary entities are not licensed CPA firms.
For additional information on topics covered in this content, contact a Grant Thornton Advisors LLC professional.
Tax professional standards statement
This content supports Grant Thornton Advisors LLC’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. It is not, and should not be construed as, accounting, legal, tax, or professional advice provided by Grant Thornton Advisors LLC. If you are interested in the topics presented herein, we encourage you to contact a Grant Thornton Advisors LLC tax professional. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein.
The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal, tax, or professional advice provided by Grant Thornton Advisors LLC. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact a Grant Thornton Advisors LLC tax professional prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton Advisors LLC assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.
Grant Thornton Advisors LLC and its subsidiary entities are not licensed CPA firms.
More SALT alerts
No Results Found. Please search again using different keywords and/or filters.