New York Tax Appeals Tribunal allows taxpayers to use combined reporting
Decision reverses lower court’s non-unitary determination
TAX ALERT |
On May 19, 2016, the New York State Tax Appeals Tribunal issued its decision in SunGard Capital Corp. and Subsidiaries, et. al., reversing an administrative law judge's finding that SunGard Group (Group) was not engaged in a unitary business. While the decision was rendered using prior New York law, it does provide guidance for purposes of determining the existence of a unitary business and is particularly relevant since both New York and New York City have adopted a mandatory combined reporting system for unitary groups beginning in 2015.
For tax years 2005 and 2006, the Group filed amended returns in New York and claimed refunds on the basis that the parent and its subsidiaries were a unitary business and that filing separate returns distorted their income. Their primary line of business was the sale and distribution of software and processing services to institutional clients, specifically those in financial systems, higher education, the public sector and availability services.
The parent company, SunGuard Data Systems, Inc. (SDS) in 2005 and later SunGuard Capital Corp. in 2006 following a transfer, owned at least 80 percent of capital stock of all the entities of the group and provided a variety of centralized corporate functions and services for the entities in the Group. Notably, they were not reimbursed for these services. These included the Group's cash flow management system, oversight of the Group's insurance matters and various audit functions, and the preparation of SEC and other public documents. Legal services and employee management services were also provided by the parent for the members of the Group. Additionally, in 2005 SDS had financed a leveraged buyout in which many of the subsidiaries were converted into disregarded entities.
Prior to 2015, New York permitted or required combined reporting where corporations satisfied a three-part test. Members of the group had to meet a substantial ownership requirement, a unitary business requirement, and a "distortion" requirement. Since there was no dispute regarding the substantial ownership requirement, the Tax Appeal Tribunal's analysis centered on whether the other two requirements were met by the Group.
With respect to the unitary business requirement, the tribunal took into consideration three leading U.S. Supreme Court cases which addressed the unitary business doctrine. The key factors to be assessed were the flow of value between members of the group and a relationship highlighted by functional integration, centralized management, and economies of scale. Evidence of these factors is demonstrated by the fact that the members are engaged in the same line of business, conduct transactions not at arm's-length, and are collectively managed by a parent with its own operational expertise and operational strategy.
Additionally, analysis of the New York Division of Taxation's unitary business regulations was undertaken by the tribunal. These regulations spelled out three factors for consideration: (1) whether the group was manufacturing or acquiring goods or property, or performing services for one another, (2) the presence of cross-selling or financing, and (3) whether or not the members of the group were in the same or similar line of business.
Applying this analysis to the business activities of the Group, the tribunal determined that the members were a unitary business. It found that not only were the members engaged in the same line of business, but the various segments provided complementary services which allowed for cross-selling. The presence of centralized management was also indicative of a unitary business in that there was a flow of value between entities. The Group possessed a centralized cash management system and corporate officers who were responsible for some if not all of the entities, which was evidence of a single corporate strategy. Consolidated purchasing services and the Group's financing commitments and arrangements also demonstrated economies of scale and the flow of value between its members.
The tribunal then addressed the issue of whether or not filing separate returns would distort the taxpayer's income as reflected in their filings. In finding that a combined return was more representative of the group's activities, the tribunal highlighted activities or transactions that created distortion. Specifically, the uncompensated support services provided by the parent resulted in a reduction of costs that would normally have been unavailable. The centralized cash management system also permitted the Group's members to access funds generated by the collective whole on an as-needed basis and interest free. Finally, the securitization arrangement for the leveraged buyout was proof of distortion since member's interest costs would have increased had they been required to obtain third-party debt financing. These costs would not have been reflected were it not for the presence of a combined return.
The end result was that the administrative law judge's decision was overturned and the Group's refund claims were upheld. The tribunal did, however, exclude certain entities from the Group on the basis that they did not meet the requirements for membership and as such, could not be included in the combined return.
While the case was addressed under prior law, the tribunal's analysis of combined reporting requirements is relevant given the adoption by the state and the city of a unitary combined reporting system effective Jan. 1, 2015. Corporations or entities that are part of affiliated groups for taxpaying purposes should take note as this decision will serve to guide the state of New York, New York City and taxpayers in determining the composition of combined groups for reporting purposes until new guidance or regulations are published by the Division of Taxation.