United States: Alaska Supreme Court Holds Combined Group Must Include Portion Of Foreign Dividends In Income Tax Base

The Alaska Supreme Court has determined that a unitary group was required to include 20 percent of foreign dividends in its combined corporation net income tax return.1 Under the Alaska net income tax, corporations must include 20 percent of dividend income received from foreign corporations. However, Internal Revenue Code (IRC) Section 882 requires a foreign corporation to report only income effectively connected with the conduct of business within the United States. Because the federal provision was inconsistent with Alaska law and not adopted by reference, Alaska law controlled and the taxpayer was required to include a portion of the foreign dividends.

Background

Schlumberger Limited ("Limited"), a multinational company incorporated in the Netherlands Antilles, engaged in services limited to the management of its subsidiaries. In addition to the fees it received for this service, Limited received dividends from its subsidiaries around the world. In Alaska, Limited operated through a wholly-owned subsidiary, Schlumberger Technology Corporation ("Technology"), which owned and operated all of Limited's associated domestic companies. Technology filed a consolidated federal tax return for all of these subsidiaries. For Technology's 1998-2000 tax years, Technology filed Alaska corporate income tax returns that included only the domestic subsidiaries in the oilfield services industry, its primary line of business.

As a result of an audit, the Alaska Department of Revenue found that Limited was engaged in a unitary business with Technology for purposes of the Alaska combined reporting statute that requires members of affiliated groups to include in their income tax returns corporations whose "property, payroll, and sales factors in the United States average 20 percent or more."2 The auditor thus concluded that Limited was a "water's edge" affiliate of Technology within the meaning of the statute. Based on these determinations, the Department assessed additional corporate income tax.

After an informal conference decision affirmed that Technology must include 20 percent of Limited's foreign dividend income in the group's apportionable income, Technology appealed to the Alaska Office of Administrative Hearings. The administrative law judge denied Technology's motion for partial summary judgment on whether Technology could be assessed based on amounts received by a related foreign corporation that were earned outside the United States. According to the judge, Alaska's change to water's edge accounting limited the types of corporations included in the unitary group for purposes of determining apportionable income but did not limit the types of income to be apportioned from the members. Accordingly, the judge concluded that Alaska's apportionment methodology should be applied to determine Technology's taxable income, declining to apply a federal provision, IRC Section 882, which excludes income not "effectively connected with the conduct of a trade or business within the United States."

Technology appealed the administrative order to the superior court, which affirmed the decision. In addition, the superior court determined that Technology did not preserve its argument that the taxation of the foreign dividends would violate the Commerce and Foreign Commerce Clauses of the United States Constitution because Technology had stipulated to withdraw this issue from consideration. Technology appealed the superior court's decision to the Alaska Supreme Court.

Federal Foreign Dividend Sourcing Rules Inconsistent with Alaska Law

In affirming the superior court, the Alaska Supreme Court began its analysis by describing the Alaska net income tax as it pertains to the filing requirements for "affiliated groups." Under Alaska's mandatory water's edge combined reporting method, the affiliated group includes only corporations that are part of a unitary business with the taxpayer and that meet a certain threshold for domestic business activity.3

With the members identified, the net business income of the affiliated group is then subject to apportionment under the Multistate Tax Compact as adopted by Alaska.4 Under the Compact, a corporation's in-state income is determined by multiplying "[a]ll business income" by an apportionment fraction, which is the average of three factors— property, payroll, and sales—which operate to compare a corporation's in-state and worldwide business activities.5

While Alaska includes 20 percent of foreign dividend income in the group's apportionable income,6 the federal sourcing regime excludes all foreign dividends received by a foreign corporation.7 Acknowledging that Alaska net income tax statutes incorporate certain IRC provisions unless "excepted to or modified by other provisions," the Court resolved the inconsistency in favor of the state statute. In support of this result, the Court cited its decision in Department of Revenue v. OSG Bulk Ships, Inc., in which the Court declared that conformity with IRC Section 883, which excludes foreign shipping income from federal taxable income, was inconsistent with the provisions of the Compact incorporated into Alaska's statutes.8 After reiterating that the sourcing provisions of the IRC are fundamentally inconsistent with the apportionment required by the Compact, the Court concluded that the Alaska statute including 20 percent of foreign dividends was an exception to Alaska's general rule of IRC conformity.

Adoption of "Water's Edge" Statute Did Not Change Reportable Income

The Court also rejected Technology's argument that, by adopting the water's edge combined reporting method—which excludes foreign companies with less than 20 percent United States activities from the affiliated group—the legislature intended to exclude all foreign income, thereby superseding the rationale behind OSG. Alaska law defines the water's edge method as a reporting method in which the only corporations that may be included in the return are the corporations that are part of a unitary business with the taxpayer and satisfy certain tests for domestic business activity.9 Because the description speaks only to the types of corporations included in the group, the Court reasoned, "[t]his language limits the corporations that must be joined in a return; it does not limit the types of income that must be reported." The Court also noted that the water's edge amendment was enacted at the same time as the provision subjecting to allocation 20 percent of foreign dividends income. According to the Court, "[i]t thus seems unlikely that the legislature intended the water's edge amendment to have the effect of excluding all dividend income received by a foreign corporation."

Subsequent Legislation Did Not Incorporate All Federal Sourcing Rules

The Court rejected Technology's contention that the post-OSG Alaska statutory amendment providing that nothing in the Alaska net income tax statutes or in the Compact may be construed as an exception to or modification of IRC Section 883 requires the federal sourcing provisions to be followed when computing Alaska taxable income.10 The Court held that Technology's argument went too far because the legislature's decision to exclude the categories of foreign income listed in IRC Section 883 did not change the fact that the total exclusion of foreign dividends under IRC Section 882 is facially inconsistent with the 80 percent exclusion provided by Alaska law.

Constitutional Claim Intentionally Withdrawn

The Court did not consider Technology's argument that the Alaska net income tax statute violates the Interstate and Foreign Commerce Clauses of the United States Constitution because the state discriminates against dividends paid by foreign corporations in favor of dividends paid by domestic corporations. According to the Court, Technology withdrew this claim in a stipulation filed during the agency proceedings. After the administrative judge denied Technology's motion for summary judgment, the parties entered into a stipulation providing that Technology withdrew any potential disputed issues not addressed in the denial order, including any issues identified in the notice of appeal. The Court rejected Technology's argument that it did not explicitly waive this constitutional argument.

Commentary

The Court's refusal to follow IRC Section 882, holding that a portion of the foreign dividends are subject to tax, was based on the conception of the Court that "the Internal Revenue Code does not use the same apportionment formula as the Multistate Tax Compact." IRC Section 882 concerns the sourcing of a foreign corporation's income to the United States. This is not the same concept as the apportionment of income between states that is addressed by the Compact. The question that arises is whether it is fair to characterize IRC Section 882 and the Compact as being in conflict, given the distinct purposes of IRC Section 882, which addresses federal income tax issues, and the Compact, which addresses multistate income tax issues.

The Court's refusal to abandon its rationale in OSG confirms its support of Alaska income tax law in the event of an inconsistency with the federal income tax approach endorsed in the IRC. In both cases, the Court took this position notwithstanding an Alaska statute that explicitly adopts by reference numerous sections of the IRC unless excepted to or modified by other provisions of the Alaska net income tax statutes.11 It thus appears the preference for Alaska law rests largely on the Court's willingness to broadly apply this language and imply such an exception should a conflict of law arise.

The Alaska Supreme Court's decision did not substantively consider Technology's constitutional argument based on the conclusion that Technology waived the right to make this argument at the administrative level. Technology argued that the Alaska net income tax statute violates the Interstate and Foreign Commerce Clauses by discriminating against dividends paid by foreign corporations in favor of dividends paid by domestic corporations.

In support of its constitutional argument, Technology cited a U.S. Supreme Court case, Kraft General Foods, Inc. v. Iowa Department of Revenue and Finance, which held that Iowa's statutory scheme of taxing the dividends that a corporation received from its foreign subsidiaries while not taxing dividends received from its domestic subsidiaries facially discriminated against foreign commerce and violated the Foreign Commerce Clause.12 As summarized by the New Hampshire Supreme Court, Kraft contains a widely-cited footnote in which the U.S. Supreme Court "distinguishes between a single entity filing system where income from out-of-state domestic subsidiaries is not taxed at all and a combined reporting method system where out-of-state domestic income is taxed through apportionment."13 Because Kraft involved a separate entity tax return of a parent company, some state courts considering similar challenges by combined groups have distinguished Kraft and held that there is no constitutional violation.14 After considering these decisions from other states, it is likely that the Alaska Supreme Court would have found against the taxpayer on the substantive constitutional arguments based on Kraft had the taxpayer been permitted to raise them.

Footnotes

1. Schlumberger Technology Corp. v. Department of Revenue, Alaska Supreme Court, No. S-14729, July 18, 2014.

2. ALASKA STAT. § 43.20.145(a).

3. ALASKA STAT. § 43.20.145(a).

4. ALASKA STAT. § 43.19.010, art. IV, ¶ 9.

5. Id.

6. ALASKA STAT. § 43.20.145(a), (b)(1).

7. IRC § 882(a)(1).

8. 961 P.2d 399 (Alaska 1998). As discussed below, the Alaska legislature responded to this decision by clarifying that nothing in the Alaska corporate income tax law or the Compact could be construed as an exception or modification to IRC § 883.

9. ALASKA STAT. § 43.20.145(a), (h)(4).

10. ALASKA STAT. § 43.20.021(h). IRC § 883 excludes income of foreign corporations derived from ships, aircraft and communications satellite systems.

11. ALASKA STAT. § 43.20.021(a).

12. 505 U.S. 71 (1992). Iowa allowed a deduction for dividends received from domestic subsidiaries, but not for those received from foreign subsidiaries. In reaching its decision, the Court determined that "commerce" includes the flow of dividends from a foreign subsidiary to its parent.

13. General Electric Co. v. Commissioner, New Hampshire Department of Revenue Administration, 914 A.2d 246 (N.H. 2006), cert denied, 552 U.S. 989 (2007). In affirming New Hampshire's dividends received deduction statute, the Court decided to "assess New Hampshire's taxing regime as a whole and look at the aggregate tax imposed upon a unitary business."

14. Id.; Fujitsu IT Holdings, Inc. v. Franchise Tax Board, 15 Cal. Rptr. 3d 473 (Cal. Ct. App. 2004); Appeal of Morton Thiokol, Inc., 864 P.2d 1175 (Kan. 1993); Du Pont de Nemours v. State Tax Assessor, 675 A.2d 82 (Me. 1996).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions