On June 30, 2008, Gov.
Deval Patrick signed into law House Bill 4904, “An Act Relative to Tax Fairness
and Business Competitiveness.” H.R. 4904, 185th Gen. Court (Mass. 2008). One of
the most important provisions of the bill is the adoption of combined reporting
in the commonwealth. Historically, Massachusetts has been a separate filing
state where each corporation subject to taxation in Massachusetts files a
separate tax return. Proponents of this bill argue that it will help Massachusetts
to maintain its competitive edge in attracting and retaining businesses. Mass.
Study Comm’n on Corporate Taxation, Interim Report, at 13
(2007). Though the impact of combined reporting is difficult to determine and
measure, it is clear that multi-jurisdictional taxpayers and tax planners will
be significantly affected. Robert Cline, Council on State Taxation, Understanding
the Revenue and Competitive Effects of Combined Reporting, at 14
(2008).
The first goal: “tax fairness”
The recent wave of states adopting combined reporting
has been largely in response to a number of tax disputes in separate filing
states where the taxpayer has taken advantage of a perceived tax loophole.
Michael Mazerov, Center on Budget and Policy Priorities, Growing
Number of States Considering a Key Tax Reform, at 4 (2007).
When elected, Patrick articulated his goal of “closing corporate loopholes” in
the Massachusetts tax code, and commissioned the Study Commission on Corporate
Taxation to study the Massachusetts tax system and make recommendations. While
the panel recommended adopting combined reporting, seven members of the
commission, including representatives from the Legislature’s Joint Committee on
Revenue, Associated Industries of Massachusetts (“AIM”), and the Massachusetts
Taxpayers Foundation, offered a minority dissenting opinion. Bradley H. Jones
Jr. et. al., Interim Report of a Minority of Members of the Study Comm’n
on Corporate Taxation, (2007). Opponents of combined reporting
across jurisdictions argue that it is not the simplest and most accurate
reflection of activities of entities within a state and that a policy of
separate filing entities is preferable. The minority of the study commission
points to a letter written by Massachusetts Commissioner of Revenue Alan
LeBovidge on April 26, 2004, to the Joint Committee on Revenue expressing
concerns regarding the adoption of combined reporting in Massachusetts
specifically.
Still other opponents argue that the policy of
combined reporting is flawed because “the interaction created an actual or
perceived disconnect in the link between the location of measurable,
state-specific factors and the attribution of income to a state.” Robert Cline,
Council on State Taxation, Understanding the Revenue and
Competitive Effects of Combined Reporting, at 4 (2008).
Separate filing mechanics
States that do not mandate combined reporting
collect business taxes at an entity level; these are known as separate filing
states. Each entity, if it is determined to have nexus in a jurisdiction,
without regard to its parents or affiliates, will submit a return based on its
taxable income in that state. Those entities that conduct business in multiple
jurisdictions will apportion their income based on the percentage of property,
payroll and sales that they have in each jurisdiction. Rules for apportioning
income vary across jurisdictions and sometimes change with the nature of the
business. Robert Cline, Council on State Taxation, Understanding the
Revenue and Competitive Effects of Combined Reporting, at 3 (2008).
Separate filing treats each entity as a single
taxpayer and is concerned only with the business and income of that taxpayer.
Those in favor of separate filing point out that this is a very predictable and
fair way to tax the income of entities, where there is a rational connection
between the entity and the jurisdictions to which they report. Robert Cline,
Council on State Taxation, Understanding the Revenue and
Competitive Effects of Combined Reporting, at 2 (2008). Those in
favor of combined reporting, on the other hand, argue that this system avails
itself to “income shifting” and abusive tax shelters. Michael Mazerov, Center
on Budget and Policy Priorities, Growing Number of States Considering a
Key Tax Reform, at 4 (2007).
Combined reporting mechanics
Unlike separate filing, combined reporting takes
into account an entity’s parent and affiliated corporation. The income of the
group is combined to find the taxable income of the unitary group; in effect,
combined reporting begins by finding the taxable income across all states of
the entire business without regard to separate legal entities. Once the nationwide
taxable income is calculated, the apportionment factors are applied to the entire
group, as opposed to each separate filing entity. A combined return includes
all entities that make up the unitary group, regardless of whether each entity
has nexus in that combined reporting state. See generally: Robert Cline,
Council on State Taxation, Understanding the Revenue and
Competitive Effects of Combined Reporting (2008); Michael Mazerov,
Center on Budget and Policy Priorities, Growing Number of States Considering a
Key Tax Reform (2007).
Application of the apportionment factors to the
income of the group, instead of the separate entities, results in
multi-jurisdictional taxpayers reporting and paying tax for entities in
jurisdictions where they may not have nexus. The Massachusetts Study Commission
on Corporate Taxation “believes that combined reporting would modernize the
corporate tax structure in the commonwealth and would reduce opportunities for
tax avoidance through transactions among affiliated corporations.” Mass. Study
Comm’n on Corporate Taxation, Interim Report, at 18
(2007).
Taxpayers that do business in multiple
jurisdictions often respond to various state incentives to attract businesses.
As a result, a complex organizational structure may have various entities or
functions spread across various jurisdictions, and those entities or functions
may frequently transact business with one another. Opponents of combined
reporting argue that it is unable to distinguish beneficial tax planning from
abusive “loopholes.” Robert Cline, Council on State Taxation, Understanding
the Revenue and Competitive Effects of Combined Reporting, at 7
(2008)
Defining a unitary business
One of the challenges for combined reporting
states has been defining what constitutes a unitary business; that is, what
entities should be included in the group whose income will be taxed as a single
business. A unitary business is defined in the bill as “the activities of a
group of two or more corporations under common ownership that are sufficiently
interdependent, integrated or interrelated through their activities so as to
provide mutual benefit and produce a significant sharing or exchange of value
among them or a significant flow of value between the separate parts.” H.R.
4904, 185th Gen. Court, § 48 (Mass. 2008) Whether affiliated corporations are
“sufficiently interdependent, integrated or interrelated” has historically been
the subject of tax controversy in combined reporting states and will likely be
an issue in Massachusetts in the future.
The revenue impact
Both supporters and opponents of combined
reporting agree that measuring the exact revenue impact of combined reporting
is very difficult due to the various factors that effect state tax revenues
from year to year. The Commonwealth of Massachusetts estimates an increase in
revenue, due only to combined reporting, of $136 million in Fiscal Year 2008
and $226 million in Fiscal Year 2009. Mass. Study Comm’n on Corporate Taxation,
Summary
of Proposed Tax Loophole Changes (2007), available at
www.mass.gov/bb/fy2008h1/bills08/fair.shtml. The projected revenue boost to the
commonwealth is the main reason for implementing combined reporting. It remains
to be seen whether these predictions pan out.
Add back provisions
In 2003, the commonwealth initially addressed
the problem of “income shifting” by multi-jurisdictional taxpayers by enacting
the “add back” statute. Mass. Gen. Laws ch. 63, §§ 31I, 31J, 31K (2008). The
statute requires entities to “add back” to Massachusetts taxable income certain
items that have been deducted for purposes of computing federal taxable income.
These items are usually inter-company expenses resulting from loans or
licensing agreements between affiliated corporations. 830 Mass. Code Regs. §
63.31.1 (2008). Combined reporting takes into account the income of the entire
unitary group but the Massachusetts add back statute may already collect a
portion of the revenue expected from the adoption of combined reporting. Robert
Cline, Council on State Taxation, Understanding the Revenue and
Competitive Effects of Combined Reporting, at 10-11 (2008).
Consider that revenue projections for combined
reporting are especially tenuous where the state already has an add back
statute. Since the goal of each is to address tax savings corporations derive
from inter-company transactions, the add back statute may already be
collecting, in large part, the revenue projected for combined reporting.
The second goal: business competitiveness
As the title of the recently passed
Massachusetts bill suggests, part of the goal in adopting combined reporting is
to enhance the competitiveness of the commonwealth in attracting businesses.
Determining and measuring the impact of combined reporting on the
commonwealth’s ability to attract business is extremely difficult, as it is impossible
to isolate any of the factors that attract businesses to Massachusetts.
Those entities that will be most affected are
those that sell products or services in broad national or international markets
and have a great deal of “mobile capital.” In most cases, simplicity or
consistency in a state tax system is important to a corporation subject to tax
in numerous jurisdictions. Frequent or significant statutory changes in the
corporate tax system may not necessarily make Massachusetts a more competitive
business environment.