Effect of Allied-Signal, Inc. v. Director, Division of Taxation, 504 US, 119 L. Ed. 2d 533, 112 S.Ct. 2251 (1992) on the Exclusion of Income Derived from the Holding or Sale of Stock in a Non-Unitary Business from Apportionable Net Income
PURPOSE: This Special Notice describes the effect of the United States Supreme Court decision in Allied-Signal, Inc. as Successor-in-Interest to the Bendix Corp. v. Director, Division of Taxation, 504 US___, 119 L. Ed. 2d 533,112 S.Ct. 2251 (1992) on the provision of Conn. Gen. Stat. Section 12-218 that allows any taxpayer that is taxable both within and without Connecticut to apportion its income.
BACKGROUND: Under the Connecticut Corporation Business Tax, any taxpayer that is taxable both within and without Connecticut may apportion its net income as provided in Conn. Gen. Stat. Section 12-218. The Commerce and Due Process clauses of the United States Constitution limit the States' authority to tax the income of a multistate business enterprise. First, there must be a minimal connection or nexus between the interstate activities and the taxing state. Second, assuming that nexus is established, there must be a rational relationship between the income attributed to the taxing state and the intrastate value of the corporate business. Mobil Oil Corp. v. Commissioner of Taxes of Vermont, 445 U.S. 425 (1980).
NONDOMICILIARY CORPORATIONS: If a nondomiciliary corporation has nexus with a state because of its interstate activities, the state may impose a fairly apportioned tax on all or part of the business activities that are related to the activities carried on within its borders. This is true whether those interstate activities are conducted through a single corporation or a group of commonly controlled corporations. The crucial inquiry focuses on the in-state and out-of-state activities that are sufficiently interconnected to justify apportionment. This concept is described as the unitary business principle.
Interstate activities are unitary, and therefore taxable in all states with which they have nexus, if there is a flow of value among the activities. A unitary business is demonstrated by the presence of functional integration, centralization of management, and economies of scale. F.W. Woolworth Co. v. Taxation and Revenue Department, 458 U.S. 354 (1982).
The application of unitary business principles to a particular business enterprise is inherently a factual determination. When a taxpayer challenges a state's authority to apportion and tax its income, the burden is on the taxpayer to establish by clear and cogent evidence that the state seeks to tax income from activities that are not unitary, or sufficiently interconnected, with the business conducted in the taxing state. Mobil Oil Corp. v. Commissioner of Taxes of Vermont, 445 U.S. 425 (1980).
DOMICILIARY CORPORATIONS: In contrast to the rules regarding nondomiciliary corporations, a state has constitutional authority to tax all of the non-unitary investment income of a domiciliary corporation, as well as a fairly apportioned percentage of its income from unitary business operations. See Allied-Signal.
THE Allied-Signal DECISION: The issue before the United States Supreme Court in Allied-Signal was whether the state of New Jersey could require Bendix, a nondomiciliary corporation to which Allied-Signal succeeded in interest, to include in its apportionable tax base a $211.5 million gain which it realized on the sale of a 20.6 percent interest in the stock of ASARCO. Because the parties stipulated that Bendix and ASARCO were entirely unrelated business enterprises, the Court found that no unitary business relationship existed between the two companies. Therefore, apportionment of Bendix's capital gain could not be justified on the basis of a unitary business relationship.
The Court acknowledged, however, that the absence of a unitary relationship would not preclude apportionment of Bendix's gain, because a capital transaction involving a non-unitary payor and payee may nevertheless have an operational function. The Court stated, ". . . for example, a State may include within the apportionable income of a nondomiciliary corporation the interest earned on short-term deposits in a bank located in another state if that income forms part of the working capital of the corporation's unitary business, notwithstanding the absence of a unitary relationship between the corporation and the bank." Allied-Signal, 112 S.Ct. 2251, at 2263.
The Court's interpretation of the facts presented led it to conclude that Bendix's holding of ASARCO stock was an investment unrelated to its business operations, even though Bendix purchased the stock pursuant to a long-term corporate strategy of acquisitions and dispositions, and even though Bendix intended to use the gain from the stock sale to finance the purchase of another corporation that would have operated as part of Bendix's unitary business. Because Bendix and ASARCO were not unitary, and because Bendix's acquisition of ASARCO stock did not serve an operational function, the Court held that New Jersey could not apportion the gain on the sale of ASARCO stock.
EFFECT OF Allied-Signal ON CONNECTICUT LAW: The Department will apply Conn. Gen. Stat. Section 12-218 in a manner that conforms with federal law, as described below.
A nondomiciliary company that is taxable both within and without Connecticut, and therefore subject to apportionment under Conn. Gen. Stat. Section 12-218, may exclude from its taxable net income any item of income which results from the holding or disposition of intangible property where (1) the relationship between the taxpayer and the business represented by the intangible property is not unitary; and (2) the acquisition of the intangible property does not serve an operational function. One example of an investment which serves an operational function and is subject to apportionment is the short-term investment of working capital.
If a taxpayer claims that one or more items of its income are not subject to Connecticut tax jurisdiction, and therefore are not apportionable, the taxpayer must disclose its claim in a statement accompanying its return. Such statement shall specify the nature of each excluded item of income and the reason that each item is not subject to Connecticut tax. The taxpayer bears the burden of proving its claim. A nondomiciliary taxpayer should not file an application under Conn. Gen. Stat. Section 12-221a to claim the exclusion allowed under this Special Notice.
EFFECT OF THIS DOCUMENT: A Special Notice is a document that announces a new policy or practice in response to changes in state or federal laws or regulations or to judicial decisions. A Special Notice indicates the Department's informal interpretation of Connecticut tax law and may be referred to for general guidance by taxpayers or tax practitioners.
EFFECT ON OTHER DOCUMENTS: None.
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