The Michigan Department of Treasury recently reminded corporate taxpayers of the December 31 deadline to file amended group returns or original separate returns in compliance with the LaBelle Management decision issued by the Michigan Court of Appeals.
In LaBelle Mgmt. Inc. v. Michigan Dept. of Treas., 888 N.W.2d 260 (Mich. Ct. App. 2016), the court eliminated constructive ownership and ownership through attribution as means to satisfy the unitary group control test, and the Michigan Supreme Court declined to hear an appeal. As a result, the Michigan Department of Treasury has acknowledged that the decision could have a significant impact on the filing status of many affiliated corporations under both the Michigan Business Tax and the Michigan Corporate Income Tax.
Michigan requires a unitary business group to file a combined return that includes each U.S. person in the unitary business group. To constitute a unitary business group, corporations must satisfy both a relationship test and an ownership control test. The ownership test, the subject of the LaBelle decision, requires that one corporate member of the group own or control, directly or indirectly, more than 50 percent of the ownership interests with voting rights of the other members. Michigan does not statutorily establish what constitutes indirect ownership.
In administrative guidance, the Michigan Department of Treasury took the position that attribution rules similar to the constructive ownership rules set forth in I.R.C. § 318 apply in determining indirect ownership. The guidance also provided that brother-sister corporations connected through common ownership where one entity indirectly owns more than 50 percent of the voting rights of the sibling entities satisfy the control test. For example, if two unrelated individuals each own 50 percent of two corporations, the department concluded that each corporation indirectly owns 100 percent of the other.
In LaBelle, two corporations (LaBelle Management Inc. and Pixie Inc.) and a limited partnership were owned by two brothers, neither of whom owned more than 50 percent of any entity during the tax years in question. On audit of LaBelle Management’s separate return, the department determined that the three entities constituted a unitary business group and concluded that LaBelle Management indirectly owned more than 50 percent of the other two entities and, thus, satisfied the control test.
The court held that indirect ownership means ownership through an intermediary, not ownership by operation of legal fiction as applied by the federal constructive ownership rules or by attribution of ownership through a common owner. As a result, no unitary business group existed because none of the entities involved in the case owned, through an intermediary or otherwise, more than 50 percent of any other entity. Following the Michigan Supreme Court’s denial of review, the department announced that it would give the appellate court’s decision full retroactive effect and apply it to all open tax years.
As a result, corporate taxpayers that have been filing returns in Michigan as a unitary business group may be required to file amended group returns or separate returns for corporations no longer members of a unitary group under LaBelle. According to the department's notice, a designated member that remains the designated member of a group that no longer contains all of its previous members must file amended returns for all open years and include on the returns only those members that satisfy the LaBelle control test.
Corporations previously included in a unitary group that do not meet the LaBelle control test must determine whether they meet the control test for inclusion in a separate unitary business group or whether they are stand-alone filers for open years. In either case, the department considers these corporations to be non-filers for the years they filed in conformance with the department's guidance on constructive ownership. These corporations now must file returns for all open years, either as a single taxpayer or as a member of a new group.
The department announced it will not impose penalties for amended group returns or original stand-alone returns that are a direct result of LaBelle. The department also will waive interest for those returns so long as they are filed by Dec. 31, 2017.
A number of other states that require combined reporting apply constructive ownership concepts to determine whether there is sufficient indirect ownership of affiliated corporations to establish a combined group. California defines a commonly controlled group of corporations as a parent corporation and one or more corporations or chains of corporations connected through stock ownership that satisfies a more-than-50-percent ownership threshold. By statute, California also provides that a commonly controlled group consists of any two or more corporations, all of whose stock representing more than 50 percent of the voting power of the corporations is cumulatively owned by members of the same family, including brothers or sisters. Thus, the two corporations and limited partnership owned by the two brothers in LaBelle would have satisfied California’s control test for a unitary business group.
Connecticut, by statute, and Massachusetts, by regulation, also incorporate by reference the constructive ownership rules of I.R.C. § 318 in determining whether indirect ownership of a corporation’s stock satisfies their respective control tests. However, because I.R.C. § 318 does not attribute ownership between siblings, the LaBelle entities probably would not have been treated as being under common control in those jurisdictions.
In contrast, Colorado requires direct ownership of stock to determine if a parent corporation and one or more corporations or chains of corporations constitute an affiliated group under common control. If the members of the affiliated group also satisfy specific tests of unity, the corporations must join in the filing of a Colorado combined report.
Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: How does your state determine if affiliated corporations are under common control for combined reporting purposes?
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