Combined Filing and Federal Public Law 86-272

By Mary C. McLaughlin

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A state combined return is based on a method for determining the portion of total income of a unitary group of corporations attributable to each taxpayer in the group. Requirements for combined filing vary by state, but generally, to be included in a combined group, the entity must be part of a unitary group and meet certain tests such as stock ownership, centralized management, and distortion. Even unitary members that are not taxable by a state are included in the combined report. This is in contrast to a state consolidated return, where the unitary business requirement generally does not apply. A state consolidated return is similar to a federal consolidated return in which the income of a group of affiliated corporations is reported.

Whether to file on a combined or a consolidated basis depends on the group’s taxable income, apportionment factors, and whether the state requires combined filings for a unitary group or allows the taxpayer a choice. Some states permit either combined or consolidated returns but not both; some allow both types of returns, and some states allow neither. New York State does not allow consolidated returns, but it does permit combined returns.

Public Law 86-272

For a state to tax income earned in interstate commerce, it must be able to show a connection—or nexus—between the state and the activities from which the income is derived. The federal Interstate Income Tax Law (P.L. 86-272) prevents a state from imposing an income tax on income derived within the state from interstate commerce if the only business activity within the state is the solicitation of orders for tangible personal property, provided that the orders are approved and filled outside the state. To be exempt by virtue of P.L. 86-272, the activities of a foreign corporation within New York State must be limited to the solicitation of orders within the state, the orders must be sent outside New York State for approval or rejection, and approved orders must be filled by shipment or delivery from a point outside New York State. In New York, “solicitation of orders” includes offering tangible personal property for sale, pursuing offers for the purchases of tangible personal property, and ancillary activities— other than maintaining an office—that serve no independent business function apart from their connection to the solicitation of orders.

Disney Enterprises, Inc.

One case involving Disney Enterprises, Inc. (Disney Enterprises, Inc. & Combined Subsidiaries, New York Division of Tax Appeals, Administrative Law Judge Unit, DTA No. 818378, February 12, 2004), concerned the relationship between P.L. 86-272 and New York State’s combined return rules. The primary question in this case was whether the New York destination sales of certain Disney subsidiaries should be included in the numerator of the receipts factor of the business allocation percentage of the combined group, despite the constraints of P.L. 86-272.

Buena Vista Home Video, The Walt Disney Catalog, Inc., and Childcraft, Inc., were members of the Disney New York combined group. Each company had sales of tangible personal property shipped to points within New York. In addition, Buena Vista had salespeople who solicited sales in New York. The Buena Vista salespeople did not carry inventory and were not allowed to accept orders, collect money, or accept returned items. Other than the cars used by its salespeople and the samples and promotional items they carried, Buena Vista did not store any inventory in New York or own or rent any property in New York. The Disney Catalog and Childcraft did not use salespeople to directly solicit sales and did not have any payroll or property in New York.

Prior to joining the Disney New York combined group, Buena Vista had filed separate New York State corporation franchise tax returns and reported a zero allocation percentage on the basis of no nexus under P.L. 86-272. The Disney Catalog and Childcraft had not filed New York returns prior to joining the New York combined group. When these three companies joined the New York combined group, they reported a New York State allocation percentage of zero and reported that none of their sales of tangible personal property shipped to points within New York State.

Upon audit, the New York State Division of Taxation included the New York destination sales of these three subsidiaries in the numerator of the sales factor. In addition, the audit made adjustments to include payroll and property factors for Buena Vista. Disney objected, maintaining that the three corporations were not New York State taxpayers and had no individual nexus with New York State.

The Verdict

According to the conclusions of law, the Disney group displayed an interdependence between entities which required that they all be included in a New York State combined report. It did not matter that some of the entities had no nexus individually. There was evidence of shared management within the Disney group, and the three entities benefited from activities performed in New York on their behalf by other members of the New York combined group. There was a synergistic relationship. The court noted that the legislative history of P.L. 86-272 and related Supreme Court decisions showed that a state may constitutionally tax the activities of a corporation when those activities are part of a unitary business that has sufficient nexus. It could not be concluded that the only business activity conducted within New York State by or on behalf of these three entities was the solicitation of orders for sales of tangible personal property.

It is the inextricable relationship of these three companies to Disney’s unitary business that resulted in the inclusion of their New York State receipts in the numerator of the sales factor, and, in Buena Vista’s case, the inclusion of New York State payroll and property in the payroll and property factors.

Mary C. McLaughlin, CPA, is a tax manager at Ciba Specialty Chemicals Corporation, Tarrytown, N.Y.




















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