Colorado Supreme Court rules on combined reporting law

Holding company lacking payroll and property not required for inclusion in parent company’s tax returns


Louise Gregory 
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Jamie C. Yesnowitz
Washington, DC
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Chuck Jones
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Lori Stolly
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On May 28, 2019, the Colorado Supreme Court affirmed a decision that the Colorado Department of Revenue could not require a parent company to include a wholly-owned holding company in its Colorado combined tax returns because the holding company lacked payroll or property and was not an includable C corporation.1 Furthermore, in the alternative, the Department could not allocate the holding company’s gross income to the parent company in order to avoid abuse and to clearly reflect income.

Background Agilent Technologies, Inc. (Agilent), a Delaware corporation headquartered in California, was the parent company of a worldwide family of affiliated corporations that developed and manufactured bio-analytic and electro-analytic devices. Due to its research and development and manufacturing sites in the state, Agilent was subject to Colorado corporate income tax. Agilent wholly owned another Delaware corporation, World Trade. During the relevant tax years, World Trade did not own any real or tangible personal property and did not have any employees or payroll. World Trade was a holding company that owned the stock of four foreign subsidiaries that operated exclusively outside the United States and generated substantial dividends.

For the 2000-2007 tax years, Agilent filed separate company Colorado corporate income tax returns and did not include World Trade even though World Trade’s foreign subsidiaries each made “check-the-box” elections to be treated as disregarded entities for federal income tax purposes. As the result of an audit, the Department required Agilent to file Colorado combined corporate income tax returns that included World Trade. Following the Department’s denial of Agilent’s protest, Agilent challenged the assessment in the Denver district court.

In granting summary judgment in favor of Agilent, the district court determined that the Department could not require World Trade to be included in Agilent’s combined return.2 World Trade did not meet the definition of an includable C corporation under Colorado law because it was a holding company with no property or payroll in the U.S. Furthermore, the court rejected the Department’s alternative argument that the inclusion of World Trade’s income in the combined return was necessary to avoid abuse and to clearly reflect income. In a unanimous and published opinion, the Colorado Court of Appeals affirmed the district court.3 The Court of Appeals agreed that World Trade was not an includable C corporation because it lacked property and payroll in the U.S.4 Also, the Court agreed that the inclusion of World Trade’s income was not necessary to prevent abuse. The Colorado Supreme Court granted the petitions to review this case.5

Colorado combined reporting Under Colorado law, “[i]n the case of an affiliated group of C corporations, the executive director may require . . . a combined report, but such report shall only include those members of an affiliated group of C corporations as to which any three of [six enumerated] facts have been in existence in the tax year and the two preceding two years.”6 This statute is commonly known as the “three-of-six test.” Colorado defines an “affiliated group” as “one or more chains of includable C corporations connected through stock ownership with a common parent C corporation which is an includable C corporation” if certain ownership requirements are satisfied.7 An “includable C corporation” is defined as “any C corporation which has more than twenty percent of the C corporation’s property and payroll . . . assigned to locations inside the United States.”8 In 1994, the Department promulgated a regulation to interpret this statute. The regulation provides that “[s]ince corporations that have no property or payroll factors of their own cannot have 20% or more of their factors assigned to locations in the United States, such corporations, by definition, cannot be included in a combined report.”9

Colorado law allows the Department to adjust the income between related C corporations if necessary to avoid abuse and to clearly reflect income.10 However, a regulation clarifies that this statute has been superseded by the combined reporting statutes discussed above as a vehicle for requiring combined reporting for affiliated C corporations.11

World Trade not an includable corporation The Colorado Supreme Court affirmed the lower state courts and held that the Department could not require World Trade to be included in Agilent’s combined returns.12 World Trade did meet the statutory definition of “includable C corporation” because it did not have property or payroll in the U.S. The Court explained that its determination was supported by the regulation providing that corporations that do not have property or payroll factors of their own cannot be included in a combined report.13 The Court rejected the Department’s argument that the regulation was inapplicable because it was intended to be limited to foreign sales corporations. As explained by the Court, the regulation does not express this limitation. Because the statute and regulation are clear and unambiguous, the Court rejected the Department’s argument that the statute was never intended to apply to wholly domestic corporations.

In further support of its determination, the Court noted that the Office of Legislative Legal Services and the full Colorado legislature effectively rejected the Department’s adoption of a regulation in 1990 that would have expanded the definition of “includable corporation” to include a corporation without property or payroll that functions through the use of an includable corporation’s personnel services or property. This regulation conflicted with the statutory requirement that an includable corporation have more than 20% of its property and payroll located in the United States.

The Court also rejected the Department’s argument that World Trade had property in the state because it used Agilent’s tangible personal property such as computers and related equipment. As noted by the Court, the record did not show how World Trade came to use the property. Therefore, the district court did not err in determining that World Trade had no property factors.

Income allocation not needed to prevent abuse The Department unsuccessfully argued in the alternative that it could allocate World Trade’s income to Agilent to avoid abuse and to clearly reflect income. The Court initially noted that the Department’s regulation undermined its argument by acknowledging that the discretionary allocation statute was superseded by the combined reporting statute as the vehicle for requiring combined reporting for affiliated C corporations. If this were not the case, “the Department could always override the result dictated by the objective tests set forth [in the combined reporting statute] merely by making a subjective determination that such an override is necessary to avoid abuse and to clearly reflect income.” Even if the discretionary allocation statute could apply, the Court concluded that it was inapplicable based on Agilent’s specific facts, as the Department’s own evidence demonstrated that Agilent’s formation of World Trade for legitimate non-tax-related purposes did not constitute abuse.

Commentary The inclusion of domestic holding companies in combined reports even though they lack property and payroll in the U.S. has received considerable attention in Colorado. By its terms, the statutory language serves to prevent the Department from including these holding companies in combined reports, but the Department has interpreted this statute to require their inclusion. The Department has contended that its regulation preventing the inclusion of holding companies that lack property and payroll is intended to apply to foreign sales corporations and not to domestic holding companies. However, this regulation does not make this distinction. The Colorado Supreme Court affirmed the district and appellate courts in holding that the Department could not include these holding companies in the combined report. Therefore, this decision provides clarity that under current law, the Department cannot force holding companies without property or payroll in the United States to be included in the combined report.

On May 31, 2019, Colorado enacted legislation to expressly address the Court of Appeals’ decisions in Agilent Technologies and Oracle determining that all holding companies without property or payroll in the U.S. are excluded from combined reports.14 The legislation, effective Aug. 2, 2019, provides that Colorado law does not exclude holding companies from a combined return due to lack of property and payroll or failure to satisfy the three-of-six test. The Colorado statute excludes only corporations with property and payroll located outside the U.S. from a corporation’s combined return. Specifically, the legislation adds a new provision stating that any C corporation formed under the laws of any state of the U.S. with de minimis or no property and payroll, is deemed to satisfy the three-of-six text.15 Furthermore, for purposes of satisfying certain parts of the three-of-six test, the legislation treats the activities of any partnership or other pass-through entity owned by a member of the affiliated group of C corporations as activities performed by that member of the affiliated group if the partnership is more than 50% owned by the members of the affiliated group.16

Because the legislation is not effective until Aug. 2, 2019, taxpayers that were required to include holding companies in combined returns even though they did not have any property or payroll in the U.S., and formed such holding companies for a legitimate non-tax business purpose, should consider filing refund claims pursuant to the Colorado Supreme Court’s decision.

1 Department of Revenue v. Agilent Technologies, Inc., Colorado Supreme Court, No. 17SC840, May 28, 2019. On the same day, the Colorado Supreme Court decided a similar case, Department of Revenue v. Oracle Corp., No. 18SC3, which expressly relied on the reasoning in Agilent Technologies. This SALT Alert focuses on the Agilent Technologies decision.
2 Denver District Court, No. 14CV393, Jan. 20, 2016. However, the district court rejected Agilent’s argument that the Department was required to respect the foreign subsidiaries’ check-the-box elections and treat World Trade and the four subsidiaries as a single C corporation for Colorado tax purposes. Under this argument, the Department could not require World Trade’s inclusion because more than 80 percent of its property and payroll was outside the U.S. The district court also rejected Agilent’s argument that World Trade did not satisfy at least three of the six factors needed to require inclusion in a Colorado combined return.
3 Colorado Court of Appeals, Division 3, No. 16CA0849, Nov. 2, 2017. Note that this decision has not yet been published in the Pacific 3d Reporter.
4 The Court of Appeals also agreed with the district court that the foreign subsidiaries’ check-the-box elections did not prevent the Department from requiring World Trade to be included in the combined returns.
5 Agilent filed a cross-petition requesting that the Supreme Court review its arguments that the Court of Appeals had rejected.
6 COLO. REV. STAT. § 39-22-303(11)(a).
7 COLO. REV. STAT. § 39-22-303(12)(a).
8 COLO. REV. STAT. § 39-22-303(12)(c).
9 COLO. CODE REGS. § 201-2:39-22-303.12(c).
10 COLO. REV. STAT. § 39-22-303(6). Under this statute, “[i]n the case of two or more C corporations, whether domestic or foreign, owned or controlled directly or indirectly by the same interests, the executive director may, to avoid abuse, on a fair and impartial basis, distribute or allocate the gross income and deductions between or among such C corporations in order to clearly reflect income.”
11 COLO. CODE REGS. § 201-2:39-22-303.6.
12 The Court did not need to address the issues concerning World Trade’s check-the-box election and the three-of-six test that Agilent raised in its cross-petition.
13 COLO. CODE REGS. § 201-2:39-22-303.12(c).
14 S.B. 233, Laws 2019. Note that the Court acknowledged that this bill was passed by the legislature after the Court heard oral argument in this case. Because the bill, if enacted, would not become effective until August 2, 2019, and clearly amended prior law, the bill did not have any bearing on the Court’s opinion.
15 COLO. REV. STAT. § 39-22-303(11)(f). The Department is instructed to adopt regulations to determine the manner in which the de minimis standard will be uniformly applied to all taxpayers.
16 COLO. REV. STAT. § 39-22-303(11)(g).

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