A case decided earlier this week by the South Carolina Supreme Court may have nationwide implications on tax reporting.
The case, Media General, Inc., et al. v South Carolina Department of Revenue, considered methods a taxpayer may request to fairly reflect its business activities on a South Carolina tax return filing.
In this case, the operations of the taxpayers various subsidiaries were integrated to such an extent that the states normal method of separate entity taxation significantly distorted the fair determination of South Carolina tax liability, said Geoffrey J. Christian, CPA, managing partner at Dow Lohnes Price Tax Consulting Group LLC.
Greenville, S.C.-based Dow Lohnes Price developed an alternative apportionment position to fairly reflect the apportionment of the taxpayers income to South Carolina, and conducted the case in partnership with Nexsen Pruet, LLC, which represented Media General before the court.
The decision recognizes that statutes providing for relief from a distortive result have no explicit limitation on the method that could be utilized to fairly reflect a taxpayers business activities. The ruling overturns the longstanding policy of the South Carolina Department of Revenue to not allow the combination of separate entities in computing tax liabilities.
In addition to expanding the taxing options available to taxpayers within South Carolina, the case provides guidance that all states and multistate businesses can now utilize in establishing their tax positions, gives taxpayers a new opportunity to appropriately match their economic activities within the state to any resulting tax liabilities, and is one of a few instances in the U.S. in which a taxpayer has been successful in utilizing relief provisions.
Media General, a Delaware corporation based in Virginia, is the parent company in a consolidated group. It and its affiliates comprise a unitary group. MG Communications and MG Broadcasting (Media General subsidiaries) each licensed their intangible assets to Media General and charged Media General a flat royalty fee. Media General then sublicensed the intangibles to MGO (another affiliate) and charged MGO a royalty fee. The revenues generated by MGO from its South Carolina broadcasting and publishing operations consisted mostly of advertising sales revenue.
South Carolina determined assessments for the three taxpayers at issue: Media General, MG Communications, and MG Broadcasting. The Department of Revenue used the separate entity apportionment method, which considers each entity as having nexus with the taxing state as a separate entity, even if it is part of a unitary business.
This is in contrast to the combined entity apportionment method, noted Christian.
Under the combined entity method, each member of a group carrying on a unitary business computes its individual taxable income attributable to activities in the state by taking a portion of the combined net income of the group through the utilization of combined apportionment factors, according to the court. One of the purposes of this method is to capture the many subtle and largely unquantifiable transfers of value that take place among related companies of a single business enterprise, the court said.
The difference in methods amounted to several million dollars. Under the separate entity apportionment method, taxes on returns filed during the audit period resulted in income taxes and license fees for the entities totaling $3,758,000, whereas the combined apportionment method resulted in tax and fees for the same entities in the amount of $863,000.
Although the Revenue Department agreed that the combined method fairly represented the corporations business activities in South Carolina, it declined to use it on the ground that it lacked the authority under the state code. The court held otherwise, finding that the allowance of any other method by the code section encompasses the combined entity apportionment method.
The section is replicated in numerous states via Section 18 of the Uniform Division of Income for Tax Purposes Act (UDITPA). There is a split of authority in other states that have adopted similar provisions, observed Christian.
A lot of separate entity states have adopted Section 18 of UDIPTA, he said. This underscores that any other method includes combined apportionment. But its important to realize that while this can be favorable to taxpayers, states can use the same method to impose assessments on companies that have been egregious in shifting income out of state by using complicated tax structures.
