United States

Utah: Company with no Property or Payroll was not a Foreign Operating Corporation; Receipts from Sell Side of Buy/Sell Agreements Included in the Sales Factor

Dec 04, 2017
From KPMG TaxWatch

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Recently, a Utah Administrative Law Judge (ALJ) addressed two issues arising from an audit of a corporate taxpayer. The first issue was whether the Division erred when it disallowed a deduction taken by the taxpayer for 50 percent of the adjusted income of certain foreign operating companies. This adjustment is allowed to corporate taxpayers that are filing on a water’s-edge basis. Under Utah law, a “foreign operating company” is a corporation that: (i) is incorporated in the United States; and (ii) 80 percent or more of whose business activity is conducted outside the United States. In determining whether the 80 percent test is met, a two-factor property and payroll formula is used. Of the 30 plus companies in question, all but one of them lacked any payroll for the tax years at issue and many had no property. The Division argued that an entity without any property or payroll could not have more than 80 percent of its business activity, as measured by property and payroll, outside the United States. The ALJ agreed and held that if a company had no property and payroll, it did not have the requisite business activity outside the U.S. to qualify as a foreign operating corporation.

The second issue raised by the taxpayer was whether the Division improperly removed the gross amount associated with the sell side of certain buy/sell agreements from the sales factor. Under Utah law, the sales factor includes all “gross amounts realized … on the sale or exchange of property … in a transaction that produces business income, in which the income or loss is recognized … under the Internal Revenue Code.” A regulation further provides that gross receipts, even if business income, do not include such items as amounts realized from exchanges of inventory that are not recognized by the Internal Revenue Code. The dispute between the Division and the taxpayer essentially centered on whether the receipts from the sell side of the buy/sell agreements were recognized by the Internal Revenue Code. The Division appeared to argue that simply because the taxpayer elected, for federal purposes, to include the sell side of the buy/sell transaction on line 1 of the federal form 1120, this did not mean the buy/sell agreement produced business income that was recognized. However, the ALJ found that the sell side amounts were recognized by the Internal Revenue Code on the federal form 1120. Removing these amounts from the sales factor, the ALJ concluded, would be contrary to the express language of the rule. The ALJ also rejected the Division’s alternative apportionment argument, which was based on the premise that including the gross amounts from the buy/sell agreements in the sales factor resulted in nearly 15 percent of the gross sales denominator being comprised of items which produced no business income. In the ALJ’s view, the Division did not prove that including the sell side receipts resulted in an apportionment factor “grossly disproportionate to the business conducted” in Utah. Please contact Michael Larkin at 801-237-1335 with questions on this decision.

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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.