On May 19, the New York State Tax Appeals Tribunal determined that certain members of a taxpayer group were permitted to file Article 9-A corporate franchise returns on a combined basis, in part because they met the unitary business requirement.1 The decision is precedential and the New York Division of Taxation is statutorily precluded from the right to appeal.2
Background
The taxpayer group largely consisted of four corporations, as well as their subsidiaries (collectively, the SunGard Group): (i) SunGard Data Systems, Inc. (SDS), incorporated in Delaware with headquarters in Pennsylvania; (ii) SunGard Capital Corp. (SCC), incorporated in Delaware with headquarters in Pennsylvania; (iii) SunGard Higher Education Managed Services, Inc. (SHEMS), incorporated in Delaware with headquarters in Florida; and (iv) SunGard Institutional Brokerage, Inc. (SIBI), incorporated in New York. The SunGard Group's primary line of business is providing information technology sales and services, such as data processing, information availability, software solutions, and software licensing. Significant centralized corporate-level functions and services existed between members of the group. No charges were imposed between related entities with respect to the services provided. Also, the SunGard Group maintained a centralized budgeting system, centralized debt, and, in particular, a centralized cash management system that allocated funds to underfunded entities on an interest-free basis.
Pursuant to a leveraged buyout in 2005, the SunGard Group went through a reorganization which resulted in its members filing original 2005 corporate franchise tax returns for the short period from August 13, 2005 through December 31, 2005 on a separate entity basis. For the 2006 calendar year, members of the SunGard Group again filed their respective original New York corporate franchise tax returns on a separate entity basis.
Subsequently, all of the members of the SunGard Group timely filed amended corporate franchise tax returns for the 2005 short period and the 2006 calendar year. Both of the amended returns were filed on a combined basis and sought refunds for the franchise tax and the MTA surcharge of almost $2.2 million. For the periods at issue, the statutory requirements for permission to file combined franchise tax reports included, namely, that a proposed group of corporations met the following: (i) the substantial ownership test; (ii) the unitary business requirement; and (iii) the "other" or "distortion" requirement.3
The New York State Department of Taxation and Finance initiated an audit which resulted in the denial of the refund claims. SunGard Group challenged this denial by filing petitions for review with the New York State Division of Tax Appeals (DTA). The petitions of the individual members of the SunGard Group were consolidated at the DTA and the parties stipulated to all issues, excepting whether the SunGard Group was permitted to file its franchise tax returns on a combined basis for the periods at issue.
In response, the administrative law judge (ALJ) denied the petitions of the SunGard Group. The ALJ noted that the SunGard Group met the capital stock requirement, but determined that it failed to satisfy the unitary business requirement to file combined New York franchise tax returns.4 Further, the ALJ found that the SunGard Group failed to meet the distortion requirement. The SunGard Group filed an exception to the ALJ's determination to the Tribunal.
Arguments on Exception
At the Tribunal level, the SunGard Group contended that it met both the unitary and distortion requirements for filing franchise tax returns on a combined basis. The taxpayers argued that all four of their business segments engaged in the provision of information technology services.
In addition, the taxpayers argued that the facts surrounding the 2005 reorganization supported the existence of a unitary business. Specifically, the taxpayers contended that the rationale for the transaction included integration of the group's management team and its goals included increasing intercompany services and transactions. Further, the taxpayers noted that the restructuring resulted in the consolidation of certain services, including purchasing, human resources and benefits, marketing, and technology. The taxpayers contended that financial services were integrated through the reorganization, including securitization agreements, financing agreements, and management fees. These financing services were also cited by the taxpayers as support for their contentions that filing franchise tax returns on a separate basis would result in distortion.
The Department argued that the ALJ's determination should be sustained. Specifically, the Department contended that the taxpayers' business segments were discrete operations and that the centralization of functions between group members did not rise to the level of a unitary business. The Department further argued that neither the holding companies, nor the businesses acquired in 2005 and 2006, were integrated for purposes of satisfying the unitary test. In addition, the Department countered the taxpayers' claim of distortion.
Certain Proposed Group Members Permitted to File Combined Returns
The Tribunal reversed the ALJ's determination and concluded that, excepting certain entities acting as holding companies, the SunGard Group met the capital stock, unitary business, and distortion requirements for the periods at issue and were, therefore, permitted to file combined franchise tax returns.
Noting that the taxpayers had the burden of proof and that the substantial ownership test was not at issue, the Tribunal focused initially upon the unitary business requirement. Before addressing the specific facts of the matter, the Tribunal explained the United States constitutional background for unitary business, including the hallmarks of functional integration, centralized management, and economics of scale.5 The Tribunal further relied upon the U.S. Supreme Court in explaining that the hallmarks of unitary business may be illustrated by the following: (i) transactions not undertaken at arm's length; (ii) a management role by the parent which is grounded in its own operational expertise and strategy; and (iii) the fact that the corporations are engaged in the same line of business.6 The Tribunal relied upon these doctrines to determine whether a unitary business relationship existed between the members of the SunGard Group and further noted their similarity to the Department's regulations which consider various factors that may exist in a unitary business.7 The Tribunal then stated that there is no single test for determining the existence of a unitary business and, therefore, that such determination is based on the facts of each case.
Based on its stated rationale, the Tribunal found that the facts supported a finding that the taxpayers, excepting certain holding companies, were engaged in a unitary business. Specifically, the Tribunal determined that the members of the taxpayers' proposed group were engaged in the same or related line of business within the meaning of the Department's regulations and the federal unitary doctrine. The Tribunal concluded that, despite differences between the specific business segments included in the SunGard Group, they were all sufficiently engaged in technology sales and services to warrant a unitary determination. Further, the Tribunal found it significant that the various related entities included in the SunGard Group served many of the same customers across different lines of business, including SIBI. In addition, the Tribunal cited the taxpayers' cash management system, common management of securities and debt, and lack of reimbursement for centralized functions, as support for the conclusion that the taxpayers had functionally integrated central management. The Tribunal also found economies of scale in the taxpayers' consolidation of purchasing services. The Tribunal looked to these same uncompensated financial responsibilities, cash management system, and securitization agreements between the members of the taxpayers' proposed group as sufficient evidence that distortion would result if the taxpayers were to file franchise tax returns on a separate basis. Further, in making the determination that separate filings would result in distortion, the Tribunal explained that the factors evidencing a unitary business are similar as those leading to potential distortion.
Exclusion of Certain Proposed Group Members from Unitary Business
While the Tribunal generally reversed the ALJ's determination and found many members of the taxpayers' proposed group to be engaged in a unitary business, the Tribunal did concur with the ALJ's determination that certain members of the taxpayer's proposed group were not engaged in a unitary business. Specifically, the Tribunal concluded that certain holding companies, inactive corporations, and an entity that only received income from a partnership within the taxpayers' proposed group did not have sufficient flow of value between themselves and the proposed group to satisfy the determination that they were operating as a unitary business during the periods at issue.8
Commentary
New York has amended its corporate franchise tax reporting requirements twice since the periods at issue.9 Interestingly, this decision provides valuable insight into the Tribunal's view of unitary business and its rationale may apply with respect to all three versions of the reporting requirements for both combination and decombination actions. The unitary requirement, in particular, exists in all three versions of New York's reporting requirements and must be met for a group of related corporations to file on a combined franchise tax basis. While the 2014 enacted tax reform marked the move to mandatory combined reporting for unitary businesses under common ownership, the New York legislature did not provide a statutory definition for the term "unitary." Juxtapose the lack of a definition with the fact that New York case law regarding unitary determinations is much less developed than that in some jurisdictions (i.e, California), and the usefulness of this Tribunal decision becomes evident.
The decision is also helpful in that it lays out the United States constitutional framework and then proceeds to take a rather expansive view of centralized management. However, the decision also leaves uncertainty with respect to specific guidance. Such uncertainty is perhaps nowhere more apparent than in the area of holding companies. The Tribunal did not find the holding companies to be operating in a unitary business with the taxpayers' proposed group, but also did not provide examples of holding companies actually operating in a unitary capacity. Similarly, inactive companies and companies that received only income from outside partnerships were also excluded from the combined unitary group. Taxpaying entities under common ownership with similar characteristics would be wise to consider whether they have a flow of value evidencing a unitary relationship. As the Tribunal determined that the record lacked evidence of the excluded holding companies' specific role or function, taxpayers should contemplate detailing the roles and functions played by such holding companies. While the decision does not address the participation in centralized cash management by the holding companies excluded from the unitary group, taxpayers may consider including such participation within the stated roles and functions of their holding companies for additional support of a unitary relationship.
The determination of whether a unitary relationship exists should be revisited for all taxpayers under common ownership filing franchise tax reports in light of the new reporting requirements effective January 1, 2015. In addition, for prior tax periods, the decision's discussion regarding distortion may prove instructive. Specifically, the Tribunal looked to the cash management system and financing obligations to make its finding of distortion. Taxpayers may consider how these aspects match their facts for any audits or challenges from tax years prior to 2015. Further, the decision may impact both ongoing audits as well as future reporting requirements and FIN 48 determinations for group filers.
Finally, the decision provides some guidance as to the issue of instant unity. The Department has previously indicated on the Frequently Asked Questions section of its Web site that the determination as to whether a corporation was instantly unitary with a taxpayer upon being acquired was a "facts and circumstances determination upon acquisition."10 As this decision includes a unitary determination with respect to entities that were recently acquired, it provides valuable insight into a particular fact pattern.
Still, there is much to consider with respect to the future of unitary determinations for New York corporate franchise tax purposes. Without legislative action to provide a formal definition of the term "unitary," taxpayers may be left waiting for more Tribunal decisions to gain valuable insight into the topic.
Footnotes
1. Matter of SunGard Capital Corp., DTA Nos. 823631, 823632, 823680, 824167, and 824256 (N.Y.S. Tax App. Trib., May 19, 2015).
2. N.Y. TAX LAW § 2016.
3. See N.Y. TAX LAW § 211.4(a) (2006); N.Y. COMP. CODES R. & REGS. tit. 20, § 6-2.1 (2006); 6- 2.2(a), (b).
4. N.Y. TAX LAW § 211.4(a) (2006); N.Y. COMP. CODES R. & REGS. tit. 20, § 6-2.2(a), (b) (2006). For the periods at issue, the requirements for permission to file combined New York franchise tax reports included: (1) the substantial ownership test; (2) the unitary business requirement; and (3) the "other" or "distortion" requirement.
5. MeadWestvaco Corp. v. Illinois Dept. of Revenue, 553 US 16, 30 (2008).
6. Allied-Signal, Inc. v. Director, Div. of Taxation, 504 US 768, 789 (1992).
7. N.Y. COMP. CODES R. & REGS. tit. 20, § 6-2.2(b) (2006). This regulation required the consideration of certain factors in determining whether a group of corporations comprised a unitary business, including: (1) whether the activities in which the corporation engages in are related to the activities of the other corporations of the group; and (2) whether the corporation is engaged in the same or related lines of business as the other corporations of the group.
8. With respect to the conclusion that the holding companies were not unitary with SunGard's combined group, the ALJ took into account a Department regulation stating that a holding company was "not necessarily unitary with the corporation it owns." N.Y. COMP. CODES R. & REGS. tit. 20, § 6-2.3(e)(3) (2006).
9. See N.Y. TAX LAW § 211.4(a) (2007) (providing that combined reporting is permitted or required where the capital stock, unitary business, and substantial transactions tests were met); N.Y. TAX LAW § 210-C (providing that effective January 1, 2015, combined reporting will be required where the capital stock and unitary business tests are met).
10. New York State Department of Taxation and Finance, Corporate Tax Reform FAQs, http://www.tax.ny.gov/bus/ct/corp_tax_reform_faqs.htm (June 15, 2015).
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