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Jamie C. Yesnowitz
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On July 9, 2019, the Montana Supreme Court held that a large multinational corporation that made a water’s-edge election correctly excluded 100% of the actual dividends it received from its 80/20 subsidiary corporations.1
In reversing the district court, the Supreme Court held that the Montana Department of Revenue incorrectly limited the taxpayer’s exclusion to 80% of the dividends received as provided by state law. Because the water’s-edge statute that covers the treatment of dividends does not address actual dividends received from 80/20 corporations, the taxpayer was allowed to exclude 100% of its dividends under the federal dividends received deduction.
The taxpayer, a large multinational corporation conducting a unitary business in Montana, made a water’s-edge election for the 2008-2010 tax years that served to exclude foreign subsidiaries from its combined group return. The taxpayer also owned several 80/20 subsidiary corporations incorporated in the United States.2
Under Montana law, the taxpayer excluded both its foreign subsidiaries and the 80/20 corporations from its water’s-edge combined group return.3
The taxpayer claimed an 80% exclusion for its 80/20 corporations’ after-tax net income under Montana law. Also, the taxpayer claimed a 100% exclusion for the dividends it actually received by applying the dividends received deduction under Internal Revenue Code (IRC) Sec. 243 to its Montana taxes.
During an audit, the Department determined the taxpayer only was entitled to an 80% exclusion for the dividends that it actually received from its 80/20 corporations. The Department assessed an additional tax of over $4 million after concluding the taxpayer needed to apportion and pay taxes on 20% of the dividends that it actually received from its 80/20 corporations. The taxpayer timely filed appeals with the Department’s Office of Dispute Resolution and later the Montana Tax Appeal Board. Because the issue concerned a legal question of statutory interpretation, the taxpayer filed a petition for interlocutory adjudication with the district court. Following the district court’s judgment in favor of the Department, the taxpayer filed an appeal.
Treatment of dividends by water’s-edge group
Montana requires corporations and one or more unitary affiliated corporations that meet a 50% ownership requirement to file a combined report.4
The state defaults to a worldwide combined return, unless a valid water’s-edge election is made in accordance with the state’s requirements.5
Most domestic corporations owned by a multinational corporation are included in the water’s-edge combined return, but 80/20 corporations that have 20% or less of their payroll and property assignable to locations within the United States are excluded.
A Montana statute provides for the treatment of dividends received by a water’s-edge group.6
Under the statute, dividends received from corporations incorporated outside the United States are considered income subject to apportionment.7
The after-tax net income of U.S. corporations that are ineligible to be included in a water’s-edge combined report is considered dividends received from corporations incorporated outside the U.S. and includible in apportionable income.8
Dividends apportionable under this statute are eligible for the state’s 80% dividends received deduction.9
Exclusion of dividends actually received
The Montana Supreme Court held that the taxpayer could deduct 100% of the dividends actually received from its 80/20 corporations for Montana tax purposes through the federal dividends received deduction under IRC Sec. 243. Unless the legislature expressly provides otherwise, a corporation is entitled to federal deductions such as those provided by IRC Sec. 243 in computing its Montana tax liability. The plain language of the Montana dividends statute10
does not expressly prohibit IRC Sec. 243 deductions, and does not address whether water’s-edge combined groups should exclude actual dividends received from 80/20 corporations. According to the Montana Supreme Court, the district court erred when it affirmed the Department’s determination that the taxpayer was entitled to an exclusion of only 80% of the dividends.
As explained by the Supreme Court, the case concerned how a multinational corporation should treat the actual dividends it receives from its 80/20 corporations. The district court held that the taxpayer was not entitled to a 100% exclusion for the dividends under IRC Sec. 243 because the dividends were apportionable as income under the dividends statute. In reversing the district court, the Supreme Court explained that in Baker Bancorporation v. Department of Revenue
it reaffirmed several prior cases holding that corporations are entitled to receive all IRC deductions when filing their Montana taxes unless the legislature has provided otherwise. Because no provisions of Montana corporate tax law proscribed the IRC Sec. 243 dividends deduction, the Court held in Baker Bancorporation
that the corporations were entitled to the federal deduction.
The Supreme Court thoroughly considered the plain language of each subsection of the dividends statute.12
The Department argued that the statute expressly provides that corporations filing under the water’s-edge election are not entitled to the federal deduction under IRC Sec. 243. The taxpayer argued that a deemed distributions provision in the statute allows for a 100% income exclusion for actual dividends received from 80/20 corporations.13
In the alternative, the taxpayer argued that it was entitled to a 100% deduction under federal law. The Supreme Court initially noted that nothing in the statute expressly prevents multinational corporations from using IRC Sec. 243 deductions. However, the Court was required to determine whether the statute provides an alternative method for excluding actual dividends from 80/20 corporations.
The Court rejected the taxpayer’s initial argument that the deemed distributions provision encompassed actual dividends that a water’s-edge group receives from 80/20 corporations. The Court concluded that the deemed distributions provision makes no mention of actual dividends and merely provides an income exclusion for the federal gross-up for foreign tax credits under IRC Sec. 78.
However, the Court agreed with the taxpayer’s alternative argument that it was entitled to a 100% deduction under IRC Sec. 243. According to the Court, none of the subsections of the dividends statute address actual dividends received from 80/20 corporations. Because the statute does not expressly prohibit the IRC Sec. 243 dividends deduction, the legislature presumably decided to make the federal deduction available to corporations. The Court held that the taxpayer correctly excluded 100% of the actual dividends it received from its 80/20 corporations when it filed its water’s-edge combined group returns.
The Chief Justice of the Montana Supreme Court filed a dissenting opinion that would affirm the district court’s decision. According to the dissent, the subsection of the dividends statute providing for the exclusion of 80% of the dividends apportionable under the statute would apply to the dividends actually received by the taxpayer from its 80/20 corporations. The dissent contended that the federal deduction under IRC Sec. 243 would not apply because Montana law provides for the treatment of the dividends received by the taxpayer.
This case is significant because the Montana Supreme Court interpreted the meaning of the treatment of dividends statute that applies to water’s-edge groups in a manner contrary to the Department and the district court. The primary question addressed by the Court was whether an actual dividend received from a subsidiary 80/20 corporation is eligible for the state’s 80% dividends received deduction or the 100% exclusion under IRC Sec. 243. The Montana Supreme Court repeatedly has concluded that the 100% exclusion under IRC Sec. 243 is appropriate, unless there is Montana legislative guidance to the contrary. The difference in interpretation focuses on whether dividends that are actually received, as opposed to after-tax net income, are governed by the statute. The Court concluded that the statute does not apply to dividends that are actually received from 80/20 corporations.
The implications of this case could be significant, particularly for taxpayers reporting large dividends from affiliated entities not included in a water’s-edge combined report or taxpayers reporting any type of deemed or actual dividend with a material presence in the state. While the state has not issued specific guidance on the treatment of global intangible low-taxed income (GILTI) to date, it is possible that such a dividend would be eligible for the state’s dividends received deduction and potentially 100% federal exclusion based on the results of this case. The Montana Supreme Court’s conclusion in this case may also be relevant in other states with a similar lack of specific language with regard to the allowance of federal deductions.
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