Corporate Close-Up: Calculating the Property Factor for First Marblehead and Other Corporations Formed for Loan Securitization Transactions


A decision soon may be forthcoming from the Massachusetts Supreme Judicial Court in the First Marblehead case. As Jennifer McLoughlin recently reported in the January 7 Daily Tax Report, First Marblehead Corp. and its subsidiary are seeking a determination that the commonwealth's apportionment formula is not internally consistent. The Massachusetts high court initially held that it is, incorrectly applying the internal consistency test on the basis of whether the taxpayers were actually subject to double taxation.

The case highlights, among other things, the uncertainties inherent in applying state apportionment formulas to nonoperating companies. In this case, it was the application of the Massachusetts apportionment formula to a corporation formed to hold interests in loan securitizations. The taxpayer lost its bid to assign the loans to a location outside the commonwealth because it could not establish that loan servicing activities carried out by independent third parties outside Massachusetts should be attributed to the taxpayer and rebut the presumption that the loans were located where the taxpayer was commercially domiciled.

The U.S. Supreme Court vacated the original decision of the Massachusetts high court and remanded the case for the court to apply the internal consistency test articulated in Maryland Comptroller of the Treasury v. Wynne, which looks to whether an apportionment scheme creates hypothetical, rather than actual, double taxation. However, "practitioners don't believe that the . . . remand will lead to a different result," as Priya Nair reported in the Oct. 23, 2015 Weekly State Tax Report.

First Marblehead Corporation and its wholly owned subsidiary, Gate Holdings, Inc., facilitated and coordinated the issuance and securitization of student loans. Loans were purchased from originating banks with financing obtained through the issuance of asset-backed securities in structured finance transactions. The originating banks entered into agreements with First Marblehead pursuant to which the banks issued loans to student borrowers and then sold portfolios of these loans to a number of different Delaware statutory trusts. The trusts, in turn, sold bonds to underwriters, who subsequently sold the bonds to investors. The loans provided security for repayment of the bonds.

Gate's role in the securitization process was to hold residual beneficial interests in the trusts, either directly or through its own wholly owned subsidiary. By the end of the tax years at issue (ending June 30, 2004, 2005 and 2006), Gate held a beneficial interest in each of 16 trusts, which held all the student loans securitized by First Marblehead. These residual interests constituted substantially all of Gate's assets, and interest on the student loans comprised substantially all of Gate's gross income for those years.

There was no dispute that Gate was domiciled in Massachusetts. The Board of Tax Appeals concluded that Gate was a financial institution, a decision that was not appealed. Financial institutions apportion income to Massachusetts under an equally weighted, three-factor formula of receipts, property and payroll. Gate had no regular place of business and no employees, payroll, tangible assets or real property. The Board agreed that Gate reported its receipts factor properly, but found that Gate's property factor was 100 percent, disagreeing with Gate's claim of zero. In other words, all the student loans in which Gate held a residual interest were "located" in Massachusetts.

To determine a financial institution's property factor under Massachusetts law, a loan is located in Massachusetts if:

  • it is properly assigned to a taxpayer's regular place of business within the commonwealth, a place with which the loan has a preponderance of substantive contacts; or
  • the loan is assigned to a place outside Massachusetts that is not a regular place of business, then it is presumed, subject to rebuttal, to be assigned to the commonwealth if that was the taxpayer's domicile at the time the loan was made.

Because Gate had no regular place of business, loans could not be assigned under the first rule. The court concluded that sourcing the loans to Gate's commercial domicile results in the most reasonable approximation of how Gate generated income. The court rejected Gate's argument that loan servicing activities, which occurred outside Massachusetts, should be taken into account because that is where the preponderance of substantive contacts occurred. The court found that Gate exerted no direct control over the administrative work of the servicers. Thus, the court held that the servicers' activities should not be attributed to Gate for the purpose of determining the preponderance of substantive contacts regarding the loans.

The determination of the property factor may have been different if First Marblehead, Gate and the loan servicers were part of a unitary business group, as illustrated by a 2008 decision of the Idaho State Tax Commission. To determine its property factor, Gate tried to assign loans to locations outside of Massachusetts where servicing activities were performed.  In the Idaho case, the in-state activities of loan servicers in a unitary business with an out-of-state securitization affiliate caused the affiliate to be subject to tax in Idaho.

Similar to the approach taken by Massachusetts, Idaho apportions business income to the state using a three-factor formula of property, payroll and double-weighted (rather than single-weighted) sales. In addition, Idaho places loans in the property factor numerator of the state with which the loans have a preponderance of substantive contacts.

Loans originated by Idaho lenders were sold to an out-of-state affiliate of the lenders for securitization. The originating lenders, however, continued to service the loans and received a fee for that service. Because the out-of-state affiliate did not maintain an office in Idaho, the primary question for the commission was whether the activities of the servicers were on behalf of the securitization affiliate and could be considered more than de minimis so that the affiliate was deemed to be transacting business in Idaho. Finding the out-of-state affiliate to be merely a securitization conduit and the servicing activities conducted in Idaho to amount to more than a de minimis administrative activity, the commission concluded the affiliate must apportion its income to Idaho and include the loans in its Idaho property factor because a preponderance of substantive contacts remained in Idaho.

Loan securitization entities are just one example of nonoperating companies that are formed to serve limited objectives. Jeffrey Reed, a member of Mayer Brown LLP's state tax practice, has written more extensively about state taxation of nonoperating companies, outlining difficulties that can arise. Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: What are the best ways to resolve disputes involving jurisdiction over nonoperating entities and apportionment of their business income?

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