United States

New York: ALJ Decision Reversed; Affiliates Allowed to File a Unitary Combined Report

Jun 01, 2015
From KPMG TaxWatch

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Recently, the New York Tax Appeals Tribunal reversed a Division of Tax Appeals ruling in which an Administrative Law Judge (ALJ) had held that certain affiliated entities were not allowed to file a unitary combined report for the tax years at issue. Although this important holding addresses pre-2015 corporate tax reform “soft distortion” combination, it does provide guidance on the meaning of a unitary business relationship that continues to be relevant for post-reform tax years. As a New York State Tax Appeals Tribunal decision, the taxpayer’s victory on its efforts to file combined for the tax years at issue is final—the State cannot appeal―and the holding constitutes binding precedent for both New York State and New York City tax matters.

The group at issue included dozens of legal entities involved in similar and related lines of business, primarily providing information technology services to financial companies, public sector entities, and educational institutions, as well as data protection and disaster recovery services for customers in all sectors. In August 2005, the taxpayer and its subsidiaries were acquired in a leveraged buyout transaction (LBO), during which time a number of the corporate entities were converted to disregarded entities (DREs) for tax purposes. In 2005 and 2006, the taxpayer and its subsidiaries filed separate company returns. The entities subsequently filed amended returns for the 2005 and 2006 tax years treating the companies as a single unitary group and requesting a refund of taxes paid. The Department of Taxation and Finance (Department) denied the application for refund and the matter eventually went before the ALJ.

Under New York law in effect at the time, taxpayers were either required or permitted to file a combined report when the companies met a stock ownership requirement, were engaged in a unitary business, and reporting on a separate basis was distortive. It was not disputed that the entities met the requisite 80 percent stock ownership requirement necessary for a unitary finding under New York law. However, the Department argued that the taxpayers were not engaged in a single unitary business and that they had failed to prove distortion.  After analyzing the facts extensively, the ALJ concluded that the provision of centralized corporate services and management oversight by the parent did not necessarily constitute functional integration, centralized management based on operational expertise, or a flow of value to the subsidiary businesses. Further, although the entities collectively provided information technology services, the ALJ determined that there was little evidence of functional integration or interdependence among the various business segments. The ALJ also found it significant that there was little cross-selling, and few intercompany transactions among affiliates, especially across the business segments. The ALJ next addressed the distortion issue, concluding that the lack of arm’s-length reimbursement from the subsidiaries to the parent did not have a significant impact on the incomes of the group, and that there was no benefit to the subsidiaries as a result of the debt incurred for the LBO. The taxpayer subsequently appealed.

The Tax Appeals Tribunal (with minor exceptions involving some inactive holding companies) reversed the ALJ, first holding that the relevant entities were engaged in a unitary business during the tax years at issue. Specifically, the various companies were all engaged in the same or related lines of business, the companies complemented each other, and there were common customers across business segments. Furthermore, centralized management was demonstrated by the group’s cash management system, the consolidation of central office functions (accounting, taxes, insurance, legal, HR, purchasing), and the existence of shared corporate officers. With respect to the distortion element, the Tribunal concluded that the taxpayers had identified several activities or transactions that rose to the level of distortion sufficient to permit combined filing, including that one affiliate was not compensated at all for providing various services to the group as a whole. Furthermore, the centralized cash management system and the securitization arrangement necessary for the LBO also resulted in distortion. As such, this decision seems to provide significant guidance on the definition of a unitary business in New York and should assist in efforts to seek combination (or avoid de-combination) in years prior to tax reform. For more questions on Matter of SunGard Capital Corp., please contact Russ Levitt at 212-872-6717.

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.