United States

Colorado: District Court Addresses When Holding Companies are Included in a Combined Return

Feb 01, 2016
From KPMG TaxWatch

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A Denver district court recently addressed a number of arguments addressing whether a domestic holding company was included in a taxpayer’s Colorado combined group. The taxpayer at issue owned a domestic holding company that in turn owned four foreign companies. The four foreign subsidiaries, which conducted no business within the United States, had made check-the-box elections to be disregarded as separate legal entities. Thus, for federal income tax purposes, the holding company and the four subsidiaries were treated as a single C-corporation. The holding company did not have any property or payroll of its own.  From 2001 to 2007, the taxpayer excluded the holding company from its Colorado combined return. The Colorado Department of Revenue audited the taxpayer’s returns and asserted that the holding company should be included in the Colorado combined group. The matter eventually went to district court.

The taxpayer first asserted that the holding company could not be included in the domestic combined group because, when counting the property and payroll of the four foreign disregarded subsidiaries, more than 80 percent of the holding company’s property and payroll was outside the U.S. The Department, on the other hand, argued that federal check-the box elections did not apply for purposes of determining whether the holding company had the requisite property and payroll outside the U.S.  In other words, the property and payroll of the foreign subsidiaries was not attributed to the holding company. The court, agreeing with the Department on this issue, held that the check-the-box regulations served a different purpose than the provisions addressing which entities were included in the combined group for apportionment purposes.  Furthermore, the court noted that the taxpayer’s interpretation would allow taxpayers to manipulate when corporations are included in the combined report and would render the rules related to this determination ineffectual.  Thus, the provision excluding companies with 80 percent or more of their property and payroll outside the US did not operate to preclude the Department from including the holding company in the combined report.

Under Colorado law, a C corporation must satisfy at least three of six factors (for the tax year at issue and the two preceding tax years) to be included in a Colorado combined report. The court next addressed, and dismissed, the taxpayer’s argument that the holding company did not meet three of the factors. Furthermore, the court dismissed the taxpayer’s argument that including the holding company in the combined report violated the Commerce Clause.

Finally, the court addressed whether the holding company was excluded because it did not have any property and payroll in the U.S. By statute, an includable corporation is any corporation with more than 20 percent of its property and payroll assigned to U.S. locations. The court noted that there was some ambiguity as to how this statute applied to a company, such as the holding company, with no property or payroll of its own.  The Department’s regulation stated that because companies with no property or payroll of their own cannot have twenty percent or more of their factors assigned to locations in the United States, such corporations, by definition, cannot be included in a combined report. The taxpayer argued that per this regulation, the holding company (with no property or payroll of its own) was by definition excluded from the combined report.  The Department, however, argued that because the holding company used the taxpayer’s property and personnel, it essentially had U.S. factors. On this point, the court agreed with the taxpayer and declined to ignore the Department’s own regulation stating that companies with no property and payroll are excluded. The court found it significant that the Department had previously promulgated a regulation requiring the inclusion of C corporations without property and payroll, but that functioned by using the personnel and property of an affiliate corporation. At that time, in 1990, the Office of Legislative Legal Services advised that the regulation was an improper interpretation of the statute. Consequently, the current version of the regulation was promulgated. In the court’s view, the rejection of the earlier regulation confirmed that the Department’s position was not valid. Therefore, the court held that the holding company was properly excluded from the Colorado combined group. The court also rejected a number of other arguments as to why the holding company should be included in the combined group, including that it lacked economic substance, and the Department’s Section 482 type powers allowed it to force combination. For further information, please contact Mark Kaye at 303-382-7855.

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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.