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Jamie C. Yesnowitz
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On Aug. 21, 2019, the Wisconsin Tax Appeals Commission ruled that distributions from limited liability partnerships (LLPs) that elect to be federally taxed as corporations are treated as dividends for purposes of Wisconsin’s dividends received deduction (WI DRD).1
The Wisconsin Department of Revenue sought to disallow the WI DRD, arguing that such distributions were not made with respect to the company’s “common stock.” By ruling in favor of the taxpayer’s motion for summary judgment, the Commission provides guidance and clarity to corporate taxpayers for the application of the WI DRD and its treatment with respect to check-the-box entities.
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, October 2014 and 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.
On Oct. 26, 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 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 during the audit period that its ownership interest in JDH-Lux was a capital interest in a partnership.
During the fiscal years ended October 2013 and October 2014, Parent and JDH-US received distributions of cash from JDH-Lux. When Parent filed its federal consolidated income tax returns and Wisconsin combined franchise tax returns for these tax years, it included these distributions from JDH-Lux as dividend income. 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 the Parent’s Wisconsin combined franchise tax returns filed for the fiscal years ended October 2013 and October 2014, it utilized a WI 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
On Oct. 16, 2017, the Department issued Parent a Notice of Office Audit Amount Due for additional tax and interest for the fiscal years ended October 2013 and October 2014, asserting that the distributions from JDH-Lux did not qualify for the WI DRD. Specifically, the Department asserted that since JDH-Lux is a Luxembourg limited partnership, its ownership interests did not constitute “common stock” as required by a plain-language reading of 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.
Application of dividends received deduction
The key issue before the Commission in this case was whether the ownership interests of JDH-Lux constituted “common stock” for tax purposes as applied to the WI DRD. 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).3
The Department disagreed with Parent’s assertion, stating 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. In the alternative, the Department argued that even if JDH-Lux were treated as issuing stock for tax purposes, such stock would not be “common,” and therefore would not qualify for the WI DRD.
Before analyzing the Department’s position, the Commission noted that Wisconsin adopts a significant portion of the Internal Revenue Code (IRC), including the check-the-box election. Furthermore, Wis. Stat. Sec. 71.22(1k) defines a “corporation” to include “all other entities treated as corporations under section 7701 of the Internal Revenue Code, unless the context requires otherwise.” Thus, since JDH-Lux made the check-the-box election to be taxed as a corporation under the IRC, the Commission concluded that JDH-Lux is to be treated as becoming a corporation for purposes of the Wisconsin corporate income tax. Furthermore, the Commission noted that since Wisconsin has adopted the federal check-the-box regulations, the deemed transaction that occurs under Treas. Reg. § 301.7701-3(g)(1)(i) applies to the Wisconsin tax code as well. Therefore, for Wisconsin tax purposes, JDH-Lux is deemed to issue common stock to its partners as a result of its check-the-box election, thereby allowing its dividend distributions to qualify for the WI DRD.
In its ruling, the Commission noted that guidance provided by the Department supported its conclusion that JDH-Lux should be treated as a corporation that issues stock for Wisconsin income tax purposes. Wisconsin Department of Revenue Publication 119 provided guidance for the Wisconsin tax treatment of limited liability companies (LLCs). Within the versions of Pub. 119 in effect during the tax years at issue,4
Section IX expressly provided that “[i]f an LLC is classified as a corporation, an LLC interest is treated in the same manner as stock.” After first noting that LLCs and LLPs “are not dissimilar in any relevant aspect,” the Commission concluded that, consistent with the Department’s own published guidance in Pub. 119,5
the ownership interests of an LLP that makes the federal check-the-box election are to be treated in the same manner as stock.
Finally, the Commission summarily dismissed the Department’s assertion that if JDH-Lux’s ownership interests were deemed to be stock, such stock would not be “common stock,” which is required under Wis. Stat. Sec. 71.26(3)(j) for a taxpayer to claim the WI DRD. Although the term “common stock” is not defined within the Wisconsin tax code or the IRC, the Commission noted that the federal check-the-box regulations do not appear to contemplate the deemed stock issued under a Treas. Reg. Sec. 301.7701-3(g)(1)(i) transaction to result in more than one type of ownership interest. As a result, none of the stock could constitute preferred stock, and therefore, the Commission concluded that such stock must be common stock.
The Commission took a reasonable approach to the case by rejecting the Department’s narrow and literal reading of Wis. Stat. Sec. 71.26(3)(j). As a result, the Commission concluded that all of the facts supported the conclusion that JDH-Lux was a corporation for Wisconsin corporate income tax purposes. In addition, the Commission noted that the Department already issued guidance to this fact pattern through Pub. 119 preventing the Department under Wis. Stat. Sec. 73.16(2)(a) from taking a contrary position during the tax years at issue.6
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.7
Therefore, it is telling that the Commission ruled in Parent’s favor, as it demonstrates the level of scrutiny that Parent satisfied to allow the Commission to conclude that the Department’s position regarding the WI DRD was erroneous.
This decision also provides 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 does not conform to IRC Sec. 965 or Subpart F of the IRC in general. Thus, foreign dividends are only taxable in Wisconsin when the cash or other property is actually distributed. Prior to the Commission’s decision, many taxpayers may have assumed that the WI DRD would apply to cash distributions repatriated after 2017 by foreign check-the-box subsidiaries to their corporate owners. With this decision, taxpayers now have additional guidance that such distributions would qualify for the WI 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.
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 WI DRD. Furthermore, to the extent that prior-year Wisconsin corporate income tax returns were filed without utilizing the WI 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 WI DRD.
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