United States

Minnesota: Commissioner’s Use of Alternative Apportionment to Disregard Taxpayer’s Business Structure Invalid

Apr 24, 2017
From KPMG TaxWatch

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The Minnesota Tax Court recently held that the Tax Commissioner erred when she attempted to adjust a banking group’s apportionment to include the interest income and loans of certain LLCs taxed as partnerships. The LLCs at issue were formed by affiliated banks (the taxpayers) to hold loans secured by real property in Minnesota. Under Minnesota law, LLCs cannot be classified as financial institutions. The stated purpose for the formation and transfer of the loans to the LLCs was to reduce the taxpayers’ Minnesota tax liability. Under the general corporate apportionment rules (rather than the financial institution apportionment rules) interest income is excluded from the sales factor and intangible property (i.e., loans) is excluded from the property factor. Applying the general corporate apportionment rules, the LLCs reported zero Minnesota apportionment on their partnership returns. Thus, none of the income and property of the LLC’s was included in the bank taxpayers’ apportionment. On audit, the Commissioner adjusted the taxpayers’ apportionment to include their pro-rata share of the LLCs’ interest income and loans (intangible property). The taxpayers protested the adjustment and the matter came before the tax court.

Under Minnesota law, the statutory apportionment methods are presumed to fairly and correctly determine a taxpayer’s income allocable to the state. The burden is on the party seeking to invoke alternative apportionment to prove that the statutory method does not fairly represent the taxpayer’s net income attributed to the state. In a previous case, HMN, the Minnesota Supreme Court held that the alternative apportionment provisions could not be used to look through or disregard a taxpayer’s chosen tax structure.  The taxpayer in HMN, in full compliance with Minnesota’s tax laws, had structured its businesses to achieve tax savings. Similarly, in the instant case the Commissioner argued that the adjustment was permissible because the taxpayers had structured their business to minimize their tax liability. However, the tax court, relying on HMN, held that the Commissioner had not met the burden of proof needed to be allowed to disregard the taxpayers’ lawfully created LLCs. The court also held that the Commissioner was in essence erroneously applying the financial institution apportionment rules to the partnerships, which directly contradicted the statutory mandate that they use the general corporate apportionment rules. Please contact Mike O’Brien at 612-305-5441 with questions on Assoc. Bank. v. Commissioner of Revenue.

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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.