United States

Minnesota: Income and Factors of Foreign Disregarded Entity Are Included in Computing Combined Group’s Taxable Income

Aug 07, 2017
From KPMG TaxWatch

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The Minnesota Supreme Court recently affirmed a tax court decision, holding that the income and factors of a foreign disregarded entity were included, along with those of its domestic owner, in the Minnesota combined return for the tax years at issue. Under Minnesota law, foreign entities are generally excluded from the combined group even if they are engaged in a unitary business with domestic entities. Another provision of Minnesota law specifically states that the definition of Minnesota net income incorporates any federal elections made by a taxpayer. The taxpayer at issue asserted that the income and factors of the foreign entity—because it had properly made an election to be treated as a disregarded entity—should be included along with those of its domestic owner. The Commissioner of Revenue, on the other hand, argued that the income and factors of the disregarded entity should be excluded due to its foreign status. After the tax court ruled that the Commissioner was required to recognize the federal election and that the consequences of the federal election must be respected for purposes of computing Minnesota tax liability, the Commissioner appealed.

Before the Minnesota Supreme Court, the Commissioner argued that, despite the federal election to be disregarded, the consequences of that election cannot be given force without impermissibly disregarding the state’s water’s-edge rule. As such, it was the Commissioner’s position (and long-standing policy as published in Revenue Notice 98-08) that the net income and factors of the foreign entity must be excluded from the combined report, despite the statutory requirement that Minnesota follow federal elections. The Minnesota Supreme Court disagreed. In its view, the tax court properly held that when the foreign entity elected to be disregarded, its income and apportionment factors were no longer those of a foreign entity; they were those of the domestic owner and there was no conflict with the water’s-edge rule. Although this holding contradicted the Commissioner’s policy, the court observed that relying on the Commissioner’s Revenue Notice would render void the statutory mandate that Minnesota recognize federal elections made by a taxpayer. Please contact Jodie Scott at 612-305-5210 with questions on Ashland Inc. and Affiliates 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.