United States

Michigan: Passive Holding Company Not Subject to City of Detroit Income Tax

Jun 19, 2017
From KPMG TaxWatch

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The Michigan Tax Tribunal recently held that a passive holding company formed to hold an investment was not subject to City of Detroit Income Tax (CDIT). After a private equity firm identified an investment opportunity in a Canadian company, the firm formed a fund to invest in the Canadian entity. The taxpayer at issue was subsequently created to hold the fund’s portion of the investment in the Canadian company. The Canadian entity paid a dividend to the taxpayer in 2010 and in 2012 the taxpayer sold its interest in the Canadian company. The taxpayer paid CDIT in 2010 and 2012 on the dividends and gain from the sale, but the City later assessed additional tax. At that point the taxpayer argued that it did not have nexus with the City and filed refund claims for all taxes paid. The matter eventually came before the Tribunal.

The CDIT applies to “the taxable net profits of a corporation doing business in the city, being levied on such part of the taxable net profits as is earned by the corporation as a result of work done, services rendered and other business activities conducted in the city.” Although the Tribunal concluded that the taxpayer was “doing business” when it was formed to hold an investment with the objective of gain or profit, the key question was whether the taxpayer was “doing business” in the City of Detroit. The City argued that the taxpayer had nexus with Detroit because it was commercially domiciled in the City, had a physical presence in the City (which appeared to be necessary for CDIT nexus), and was unitary with an entity that operated in the City. The Tribunal first determined that the phrase “commercial domicile” was irrelevant to the determination of whether the taxpayer had Detroit nexus. As a passive holding company, the taxpayer did not engage in an active trade or business that required either a physical location or express direction or management. Rejecting the City’s reliance on an earlier Louisiana case, the Tribunal ruled that the City did not prove that the taxpayer’s commercial domicile was in Detroit. The next issue was whether the taxpayer had a physical presence in Detroit because it had agents (officers and directors) present in the City and contracted with other companies that performed consulting services in the City. The Tribunal determined that the activities performed in the City by the directors and officers were at the direction and control of the private equity fund and were not attributed to the taxpayer. Furthermore, the use of professional consultants in the City did not establish physical presence for the taxpayer, as the CDIT ordinance specifically excludes the activities of professionals providing services if those services are not significantly associated with the taxpayer’s ability to establish and maintain a market in the state. The Tribunal also determined that the taxpayer’s use of a Detroit address on its federal tax returns was for administrative convenience and did not equate to a physical presence in the City. Finally, the Tribunal rejected the City’s assertion that the taxpayer had nexus with the City because it was part of the private equity fund’s unitary business that was based in Detroit. As support for this position, the City cited to Michigan RAB 2014-5, which states that as “long as one member of a unitary business group has nexus with Michigan, all members of the unitary business group must be included when calculating the taxpayer’s corporate income tax base and apportionment formula.” In the Tribunal’s view, this RAB was addressing the computation of a group’s tax base and apportionment and did not mean that if one member of a unitary group had Michigan nexus, nexus was imputed to all other group members. Please contact Mike Deal at 312-665-1798 or Mike Bozimowski at 313-230-3183 with questions on Apex Laboratories Intl. Inc. v. City of Detroit.

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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.