H. Jacob Lager

International sales and state and local taxation: Closer than you may think

In Business tax rate, Business tax rates, Court decisions on August 3, 2012 at 6:38 am

Michigan allows domestic corporation to aggregate with foreign entity

The mainstream media (first time I’ve ever used that term this election cycle!) often portrays the use of foreign business entities as an arcane, indecipherable tax-dodging practice available only to huge corporations and the very wealthy.

The truth is far more mundane and, therefore, relevant to growing middle-market and closely-held businesses.

Take, for example, this past Tuesday’s re-issuance of a May 15, 2012 decision by the Michigan Court of Appeals.   In Wheeler v. MI Dept. of Treasury,  the court held that the shareholders of a domestic S-corporation were entitled to combine that corporation’s income with that of its subsidiary foreign partnerships when determining how to properly apportion state income tax liability.

So what does all that mean?

How Multi-State Allocation Works

Like many states, Michigan relies on statutory rules of allocation to determine which income from out-of-state activities are not subject to Michigan income taxes.  Some taxpayers can easily identify out-of-state activities and thereby allocate their income to specific geographic areas.  Others often encounter difficulties attempting to make such an allocation.  States are allowed to tax these multi-state operators on an apportionable share of their multistate business attributable to their jurisdiction.  This is known as the “Unitary Business Principle” (or “UBP”) and is often expressed within a state’s revenue statutes in the form of a formula that accounts for factors such as the taxpayer’s in-state property, payroll and sales.

In Wheeler, the taxpayers were the individual owners of a Michigan S Corporation with underlying foreign subsidiaries that were also transparent for tax purposes.  The owners treated their income from all their domestic and foreign pass-through entities as a unitary business and included in their UBP apportionment calculation the factors attributable to their foreign entities, resulting in a lower Michigan tax bill.  Michigan argued that UBP did not allow consideration of the foreign entities’ activities.

The Decision

In holding for the taxpayers, the court noted that “the plain language of the [statute] requires unitary, international businesses to apportion their income, and the plain language of the [statute] in effect during the years at issue required unitary, international businesses to include international apportionment factors in the calculation of property, payroll, and sales factors. . . . [T]herefore, we enforce the statute as written and follow the plain meaning of the statutory language.”

The Takeaway

When you or your clients plan for next year’s anticipated total tax obligations, don’t automatically assume that international operations are entirely separate from domestic.  You might be leaving money on the table if you don’t examine a full unitary approach for all your operations.

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  1. It’s true, there are many businesses dealing with this very thing that aren’t the multi-billion-dollar behemoths that most people assume. I have several clients who are going through this now. I didn’t have this case law, so thanks for posting.

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