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Jamie C. Yesnowitz
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On March 9, 2020, the Wisconsin Circuit Court for Dane County upheld a ruling of 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.” By upholding the Commission’s ruling in favor of the taxpayer’s motion for summary judgment, the Circuit Court provides further guidance and clarity to corporate taxpayers for the application of the Wisconsin 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 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.
Application of DRD
The Circuit Court considered two issues in evaluating the Commission’s decision: (i) whether JDH-Lux was a corporation under Wis. Stat. Sec. 71.22(1k); and (ii) whether the distributions made by JDH-Lux qualified for the Wisconsin 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).4
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.
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 Code5
does not contain any statutory language allowing distributions from partnerships to be treated as dividends.
In analyzing the Department’s position, the Circuit Court first considered whether the definition of a corporation under Wis. Stat. Sec. 71.22(1k) is ambiguous.6
The Department argued that a plain language reading of the “unless context requires otherwise” portion of this definition led to the conclusion that JDH-Lux is not a corporation because, as a partnership, it does not issue common stock. The Circuit Court summarily rejected this argument, concluding that Wis. Stat. Sec. 71.22(1k) is unambiguous, and that nothing in Wisconsin’s DRD statute provides that the definition of a corporation for Wisconsin DRD purposes is different from the definition of a corporation under Wis. Stat. Sec. 71.22(1k).
Having concluded that JDH-Lux was a corporation under both Wisconsin statutory provisions, the Circuit Court then considered whether JDH-Lux satisfied the “common stock” requirement under Wis. Stat. Sec. 71.26(3)(j) to qualify for the Wisconsin DRD. Acknowledging that the interpretations of the statutory “common stock” requirement by both Parent and the Department were reasonable, the Circuit Court determined that this statute is ambiguous.
In considering the ambiguity of the Wisconsin DRD statute, the Circuit Court explained that two questions needed to be answered: (i) whether the distributions made by JDH-Lux constituted “dividends;” and (ii) whether, if the distributions were dividends, they were made with regard to “common stock.” In response to the first question, the Circuit Court analyzed the legislative history of former Wis. Stat. Sec. 71.316, which defined a “dividend” as “any distribution of property made by a corporation to its shareholders out of its earnings and profits.” Having previously concluded that JDH-Lux was a corporation for Wisconsin tax purposes, the Circuit Court determined that the cash distributions by JDH-Lux at issue constituted dividends under Wisconsin’s broad definition of the term.
The Circuit Court then considered whether the ownership interests issued by JDH-Lux constituted “common stock” for purposes of the Wisconsin DRD. First, the Circuit Court noted that the term “common stock” initially appeared in Wis. Stat. Sec. 71.26(3)(j) in 1979, and that this language has not been changed in over 40 years. The Circuit Court also highlighted that legal entities such as LLPs and limited liability companies (LLCs) were not prevalent in the U.S. until the 1990s. Based on this timeline, the Circuit Court concluded that the 1979 Wisconsin Legislature did not seek to intentionally exclude LLPs and LLCs from Wis. Stat. Sec. 71.26(3)(j), as such legal entities were not common at the time the Wisconsin DRD statute was first enacted.
The Circuit Court concluded its analysis by ruling that the cash dividend distributions by JDH-Lux were made with regard to common stock, and therefore qualified for the Wisconsin DRD. In reaching this conclusion, the Circuit Court noted that the Department’s position regarding the “common stock” requirement of Wis. Stat. Sec. 71.26(3)(j) would mean that practically all non-C corporation business entities treated as corporations under IRC Sec. 7701 would be ineligible for the DRD. Noting that such an interpretation “would create an absurd and unreasonable result,” the Circuit Court held that a distribution made by any corporation as defined in Chapter 71 of the Wisconsin Code is made “with respect to common stock” sufficient to qualify for the Wisconsin DRD.
The Circuit Court, in upholding the ruling of the Commission, rejected the Department’s narrow and literal reading of Wis. Stat. Sec. 71.26(3)(j). As a result, the Circuit Court concluded that all the facts supported the conclusion that JDH-Lux was a corporation for Wisconsin corporate income tax purposes. While the Department sought to alter its arguments in light of the Commission’s analysis of the issue, the Circuit Court was not sufficiently persuaded to overturn the Commission’s decision.
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 both the Commission and the Circuit Court ruled in Parent’s favor, as it demonstrates the level of scrutiny that Parent satisfied to allow the Commission and the Circuit Court to conclude that the Department’s position regarding the Wisconsin DRD was erroneous.
The Circuit Court’s decision 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 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. 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; if so, such an appeal is due within 90 days of the Circuit Court’s 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.
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