Combined ReportingCombined Reporting

Cindy AvretteRevenue Laws Study CommitteeDecember 12, 2006

Combined ReportingCombined Reporting WHAT IS IT?WHAT IS IT?

It is a method of calculating the income of a group of affiliated corporations for tax purposes

HOW?HOW?It looks beyond the legal structure of separate incorporations to determine whether two or more affiliated corporations are engaged in a single unitary business

WHY?WHY?To ensure the income of a multiple entity unitary business computed and apportioned in the same manner as a single corporate business

Advantages of Combined Advantages of Combined ReportingReporting

Comprehensive way to nullify income shifting strategies

Provides a more level playing field Means to modernize state tax code to

adapt to the growth of multi-state corporations – Recommended by Governor’s Commission to Modernize State Finances in 2002

What is Combined Reporting?What is Combined Reporting?

An accounting of the total income derived by a group of affiliated corporations from the operation of its unitary business.

A unitary business is a common enterprise engaged in by one or more members of a group of affiliated entities.

What is a Combined Report?What is a Combined Report?

It is NOT a tax return. It is an accounting document

prepared on behalf of a group of affiliated corporations engaged in a unitary business.

Only those members of a unitary group that have nexus with NC pay corporate income tax to NC – Based on the combined group’s net income

Questions to AnswerQuestions to Answer

Mandatory v. voluntary Definitions

Affiliated corporations Unitary business

Type of Combined Reporting Worldwide Water’s Edge

Method of Apportionment

Mandatory v. voluntary Mandatory v. voluntary

Elective combined reporting would do nothing to reduce the tax planning opportunities – one of the primary benefits of combined reporting

Questions to AnswerQuestions to Answer

Mandatory v. voluntary Definitions

Affiliated corporations Unitary business

Type of Combined Reporting Worldwide Water’s Edge

Method of Apportionment

Who must file a combined Who must file a combined report?report?

CorporationsCorporations that are affiliatedaffiliated and that are engaged in the same same

unitary business. unitary business.

Corporations Corporations ...

All corporations that are subject to corporate income tax or would be subject to the tax if doing business in this State Insurance companies – No. Financial institutions. – Yes. REITs and RICs. – Yes. Non-US corporations. – Yes, if worldwide

combined reporting

… that are affiliated affiliated …

More than 50% common stock ownership

Familiar rule with wide spread acceptance

and engaged in the same unitary business.

No universally accepted definition Vertically or horizontally integrated Established judicial tests

Unity of ownership, use, and operation Contribution or dependency Centralized management Functional integration Economies of scale Flow of value

Multistate Tax Commission (MTC)Multistate Tax Commission (MTC)

A that is made up either single economic enterprise of separate parts of a single business entity or of a commonly controlled group of business entities that are sufficiently interdependent, integrated and interrelated through their activities so as to provide a synergy and mutual benefit that produces a sharing or exchange of value among them and a significant flow of value to the separate parts.

Center for Policy AlternativesCenter for Policy Alternatives

A group of corporations that are related through common ownership, and, by a preponderance of the evidence, are economically interdependent with one another as demonstrated by the following factors:a. Centralized management;b. Functional integration; andc. Economies of scale.

AlaskaAlaska A business is unitary if the entity or entities

involved are owned, centrally managed, or controlled, directly or indirectly, under one common direction which can be formal or informal, direct or indirect, or if the operation of the portion of the business done within the state is dependent upon or contributes to the operation of the business outside the state.

CaliforniaCalifornia

Does not have a statutory definition. Its Code of Regulations provides

guidelines on what a unitary business is.

ColoradoColorado Unique attempt to provide a bright-line test Must find at least three of the following six

factors are present for the current year and the two preceding tax years: Intercompany sales or leases Services provided by one for others Long-term debt Use of proprietary materials owned by another Common corporate control Common corporate management

IllinoisIllinois

A group of persons related through common ownership whose business activities are integrated with, dependent upon and contribute to each other.

HawaiiHawaii

Business carried on by a group of entities that includes the taxpayer where there are flows of value among the entities resulting from (1) functional integration, (2) centralization of management, or (3) economies of scale.

MinnesotaMinnesota

Business activities or operations which result in a flow of value between them. … Flow of value is determined by reviewing the totality of facts and circumstances of business activities and operations.

MontanaMontana

The business operations conducted by the corporations in the affiliated group are interrelated or interdependent to the extent that the net income of one corporation cannot reasonably be determined without reference to the operation conducted by the other corporation.

NebraskaNebraska

A business that is conducted as a single economic unit by one or more corporations with common ownership and shall include all activities in different lines of business that contribute to the single economic unit.

New Hampshire and VermontNew Hampshire and Vermont

One or more related business organizations engaged in business activity both within and without this state among which there exists a unity of ownership, operation, and use; or an interdependence in their functions.

OregonOregon A corporation or group of corporations

engaged in business activities that constitute a single trade or business.

A single trade or business is a business enterprise in which there exists directly or indirectly between the members … a sharing or exchange of values …

UtahUtah A group of corporations that are related

through common ownership and by a preponderance of the evidence as determined by a court of competent jurisdiction or the commission, are economically interdependent with one another as demonstrated by the following factors: Centralized management Functional integration Economies of scale

Definition of unitary businessDefinition of unitary business

Different definitions – Same concept Proposal: Broad definition

Less opportunity for manipulation Lower compliance costs

Questions to AnswerQuestions to Answer

Mandatory v. voluntary Definitions

Affiliated corporations Unitary business

Type of Combined Reporting Worldwide Water’s Edge

Method of Apportionment

Worldwide v. Water’s EdgeWorldwide v. Water’s Edge

Two general approaches on how to deal with a unitary group member that is incorporated in a foreign country

Prevailing position is worldwide combination with a water’s edge election

Worldwide combinationWorldwide combination Consistent with concept that a unitary

business should be taxed without regard to its organizational structure.

Constitutionality valid. Controversial.

Distortions in property and payroll factors. Difficulty of accounting and audit. Business community does not favor it.

No major industrialized country requires it for income tax purposes.

Water’s edge combinationWater’s edge combination

Exclude 80/20 corporations – A corporation whose business activity outside the US is 80% or more of the corporation’s total business activity.

Avoids the compliance burden of a worldwide combination.

Worldwide Combination with Worldwide Combination with Water’s Edge ElectionWater’s Edge Election

Water’s edge group includes: U.S. corporations Non-U.S corporations that do not meet

the 80/20 test Corporations doing business in tax-haven

countries Related intangible holding companies

Water’s Edge ElectionWater’s Edge Election Election must be in writing Election binding for an initial period of

time (MTC = 10 yrs) Election automatically extended

unless notice given of intent not to renew before the end of the last two years of the election period

If election terminated, cannot be renewed for minimum period of time

Questions to AnswerQuestions to Answer

Mandatory v. voluntary Definitions

Affiliated corporations Unitary business

Type of Combined Reporting Worldwide Water’s Edge

Method of Apportionment

Apportionment FormulaApportionment Formula

Prevent income from being taxed twice

Three factor formula Property in NC/Total property Payroll in NC/Total payroll Sales in NC/Total sales

Property + Payroll + 2(Sales)/4 = Apportionment Percentage

Apportionment of Income – Apportionment of Income – Single entity reportingSingle entity reporting Calculate apportionable taxable income

under NC law Calculate apportionment percentage using

the apportionment formula(Property + Payroll + 2(Sales)/4)

Multiply apportionable taxable income by apportionment percentage to determine apportionable taxable income

Apportionable income + Nonapportionable income allocated to state = taxable income

Apply the tax rate to taxable income

Apportionment of Income – Apportionment of Income – Combined ReportingCombined Reporting

Calculate apportionable taxable income under NC law for entire combined group (subtracting income from inter-company transactions)

Calculate apportionment percentage by applying the apportionment formula using the aggregate factors of the combined group (payroll, property, sales)

Multiply apportionable taxable income for entire combined group by apportionment percentage to determine the State net income of the unitary business

Taxation of individual members Taxation of individual members of unitary groupof unitary group Members calculate own apportionment

percentage based upon their payroll, property, sales

Apply apportionment percentage to the combined group’s net taxable income = net taxable income of taxpayer from unitary business

Taxpayer’s NC taxable income = this amount + apportionable income derived from other business activities + nonapportionable income allocated to NC

Apportionment of Income – Apportionment of Income – Combined ReportingCombined Reporting

Calculate apportionment percentage by applying the apportionment formula using the aggregate factors of the combined group (payroll, property, sales) Property in NC/Aggregate property Payroll in NC/Aggregate payroll Sales in NC/Aggregate sales X 2

Method of Apportionment:Method of Apportionment:“… in North Carolina”“… in North Carolina”

Finnigan: include the property, payroll, and sales of those members in the State, regardless of nexus Prevents tax planning techniques for isolating

sales in non-nexus affiliates Constitutionality unclear/Litigation more likely

Joyce: include only the property, payroll, and sales of those members that have nexus with the State in the numerator Most accepted method Tax avoidance strategies exist

MTC RecommendationMTC Recommendation Joyce method of apportionment Adopt a throwback provision

Sales are sourced to the destination state

Throw-back causes the sales to be sourced to the state from which the property was shipped if the destination state does not impose income tax

Provision resolves some of the tax avoidance strategies

Proposal …Proposal … Mandatory combined returns Definitions

Affiliated corporations – 50% Unitary business – Broad

Type of Combined Reporting Worldwide with Water’s Edge Election

Method of Apportionment Joyce method Throw-back provision