TWIST - This Week in State Tax

Missouri: REIT Dividends Deductible in Determining Bank’s Taxable Income

The Missouri Administrative Hearing Commission recently concluded that dividends received from a Missouri REIT were deductible in determining Missouri taxable income. The corporate taxpayer at issue was a bank that deducted distributions from a REIT on its Missouri consolidated corporate income tax returns. As part of an audit, the Missouri Department of Revenue removed the distributions from the calculation of the taxpayer’s Missouri dividends received deduction on the basis that they were REIT dividends. The taxpayer protested, and the matter eventually came before the Commission.

Under Missouri law, a corporation is entitled to a subtraction for “to the extent included in federal taxable income, corporate dividends from sources within Missouri.” There is no Missouri statutory definition of “dividends” or “corporate dividends,” but Missouri law provides that terms used in the state statutes are to be giving the same meaning as under federal law unless a different meaning is clearly required. The Commission noted that IRC section 316 defines dividends; this definition captured REIT dividends. IRC section 243, on the other hand, determines the circumstances under which a corporation may deduct dividends received. REIT dividends are not treated as dividends for purposes of IRC section 243.  In an earlier Missouri Supreme Court case, Dow Chemical, the state’s high court had held that it was the treatment of income as dividends that determined whether they were deductible. However, the Commission noted that the instant matter was not governed by Dow. In Dow, the issue around treatment was related to whether certain types of undistributed income that were not dividends should nevertheless be treated as dividends. In contrast, the REIT dividends were dividends under federal law; they simply were not deductible for federal purposes. Because the Missouri statute allows a deduction for corporate dividends not deductible under federal law, the Commission concluded that the statute was intended to capture dividends, like the REIT dividends, that could not be deducted from federal income. Please contact Derek Love with questions on Great Southern Bancorp. Inc. v. Director of Revenue.

New York: All Combined Group Members must be Qualified Emerging Technology Companies (QETCs) to Utilize Lower Rate

The New York Tax Appeals Tribunal has upheld an Administrative Law Judge (ALJ) determination that a taxpayer combined group was not a “qualified emerging technology company” or QETC able to use the lower corporate rate applicable to Qualified New York Manufacturers for the 2012-2014 tax years at issue. The taxpayer, an affiliated group of companies providing video, high-speed data, and digital voice services to both residential and business customers, filed its New York combined returns using the rate applicable to QETCs. After an audit, the Division determined that the group was not a QETC and applied the regular 7.1 percent rate.    Under New York law for the tax years at issue, a “qualified emerging technology company” was a “qualified New York manufacturer” eligible for reduced tax rates. There were two separate methods by which a party could be classified as a “qualified New York manufacturer.”  The first (“Method One”), specifically measured a combined group’s overall activities; the second method (“Method Two”), which was applicable to QETCs, did not specifically state that the combined group’s attributes should be considered together.  The dispute came before the Division of Tax Appeals and the ALJ ruled in the state’s favor. In the ALJ’s view, the legislature’s failure to include language specifically addressing the computation at the group level (Method One language) in the statutory section describing Method Two was deliberate. The ALJ also rejected the taxpayer’s position that if the combined group did not qualify as a QETC the individual entities of the group that separately qualified as QETCs should be allowed to use the lower rate.  In the ALJ’s view, separately breaking out individual component companies of a combined taxpayer was not specifically authorized by statute, and the taxpayer had not proven that de-combination would not create distortion.

On appeal, the Tribunal reviewed the statutory language for both Method One and Method Two and ultimately agreed with the ALJ’s conclusion that each and every member of a combined group, tested separately, must be a QETC, for the group to be considered a QETC. This position, the Tribunal noted, was incorporated into the newly adopted corporate tax regulations (though those regulations are not applicable to pre 2015 tax years). With respect to whether the QETC group members individually could take advantage of the lower rate, the Tribunal determined that position was inconsistent with the rules addressing how a combined group computes its franchise tax liability and would in essence de-combine the group without express permission. After addressing the statutory arguments, the Tribunal next addressed a constitutional challenge made by the taxpayer that the ALJ had rejected. The Tribunal is precluded from considering a constitutional challenge on its face and the taxpayer, the Tribunal determined, was making a facial challenge when it argued that requiring all members of the combined group to be in New York for the group to be considered a QETC discriminated against interstate commerce. 

Next Steps and Contacts: The taxpayer has the right to further appeal to an intermediate appellate court within four months of the Tribunal’s decision. If the taxpayer appeals to the courts and ultimately loses, or if it chooses to not appeal, then the court’s (or final Tribunal) decision would constitute binding precedent.  It should be noted that the standard of review applied by the appellate courts to a decision by the Tribunal is generally a very deferential one, by which the Tribunal’s decision would be affirmed unless it lacks a rational basis in its interpretation of the tax law.  Please contact Russ Levitt or Aaron Balken with questions on Matter of the Petition of Charter Communications, Inc. and Combined Affiliates, F/K/A Time Warner Cable, Inc. and Combined Affiliates (N.Y. Tax App. Tribunal, Dkt. No. 829691, Jan. 25, 2024). 

Multistate: States Propose Various Combined Reporting Changes

State legislatures are generally back in session, or will soon be in certain states. One state tax topic that is always of interest to multistate taxpayers is proposed bills to shift states to mandatory unitary combined reporting. Currently, no U.S. state requires worldwide combined reporting; but certain states, such as Minnesota, Hawaii, and New Hampshire, considered worldwide combined reporting proposals in 2023. So far, in 2024, two bills that would adopt worldwide combined reporting have been introduced in Tennessee (House Bill 2043 and Senate Bill 1934). Currently, Tennessee is a separate reporting state. These bills would also repeal the sales and use tax on the retail sale of food and food ingredients. While there is no formal bill proposed yet, legislators in Vermont are reportedly studying a draft bill that would implement worldwide combined reporting.  This comes on the heels of prior legislative changes made to Vermont’s combined reporting rules that require, beginning with the 2023 tax year, U.S.  organized corporations with significant foreign activity to be included in the combined group. Colorado House Bill 24-1134 would make the state's corporate income tax more uniform by “replacing the current combined reporting standard with the Multistate Tax Commission's standard and modifying the computation of the receipts factor to make it more congruent with the unitary business principle.”  In New Mexico, Senate Bill 181 would change the makeup of the water’s-edge combined group to exclude only “foreign” corporations with less than 20 percent of their property, payroll and sales sourced to locations within the United States. Currently, the exclusion applies to all such corporations, wherever organized or incorporated.  The bill would also eliminate the exclusion for Subpart F income. Finally, in South Carolina, Senate Bill 298 adopts specific standards under which the Department of Revenue may require a combined return or adjust a taxpayer’s income if, for instance, intercompany transactions lack economic substance or are not at fair market value. The bill sets forth criteria for determining if these conditions are met (i.e., in determining whether transactions between members of the affiliated group of entities are not at fair market value, the Department must apply the standards contained in the IRC section 482 regulations). Another section of the bill addresses which entities could be included in a combined group. This bill passed the House on February 2, 2024 with amendments, and it now returns to the Senate, which had passed an earlier version last year. Stay tuned to TWIST for updates on these bills.