On August 27, the South Carolina Department of Revenue issued a private letter ruling that permits a group of subsidiary corporations of a foreign corporation to file a single South Carolina consolidated return even though the subsidiaries were required to file two different consolidated returns for federal income tax purposes.1 The Department adopted the position that as long as the subsidiaries had income tax nexus with the state and also met the "substantial control" test, they could be included on the same consolidated return regardless of whether the common parent corporation was included on the return.
Background
A parent company (Parent), organized outside the United States, owned a controlled group of entities that manufactured and sold automotive components. As a foreign company, Parent was not subject to federal or South Carolina corporate income tax.
Parent owned 100 percent of a series of foreign disregarded entities that did not have nexus with South Carolina. These foreign disregarded entities owned 100 percent of two groups of subsidiaries that engaged in a multistate business, conducted business within South Carolina and had income tax filing requirements with the state. Both of these groups had lower-level subsidiaries that conducted activities in the state that subjected them to South Carolina corporate income tax, but some of the lower-level subsidiaries did not have nexus with South Carolina. Both subsidiary groups filed their own federal consolidated returns that included lower-level subsidiary corporations for which the federal ownership and control requirements were met.
Because Parent was a foreign corporation, it was ineligible to file a federal consolidated return with the two subsidiary groups.2 Also, the subsidiary groups could not file a single federal consolidated return because they were unable to include the common parent corporation in the return. All of the companies in both subsidiary groups used the same accounting year. The two subsidiary groups asked the South Carolina Department of Revenue whether they could file a single state consolidated return together.
Subsidiary Groups May File Single Consolidated Return
Under South Carolina law, a consolidated return is permitted for "a parent and substantially controlled subsidiary or subsidiaries" or "two or more corporations under substantially the entire control of the same interest."3 "Substantially controlled" or "under substantially the entire control" means the ownership of at least 80 percent of the total combined voting power of all classes of stock of all corporations that are part of a consolidated return.4 Also, all corporations included in a consolidated return must be subject to South Carolina corporate income tax and use the same accounting year.5 A South Carolina consolidated return does not allow for intercompany eliminations of income, expense or apportionment factors, but rather is a post-apportioned combination where the separate entity apportioned income or losses are "consolidated" into a single income or loss. Further, credits and net operating losses of the members may be utilized by the group.6
The Department clarified that disregarded entities for federal income tax purposes are also disregarded for South Carolina income tax purposes. Under the facts presented to the Department, qualifying members of each group could file the same South Carolina consolidated return. To qualify for the same return, at least 80 percent of the total combined voting power of all classes of stock of the corporations must be under the control of the same entity. However, contrary to the federal concept of a consolidated group, the entity controlling the corporations is not required to be part of the South Carolina consolidated group.
Due to the fact that Parent owned the disregarded entities that in turn owned the subsidiary groups, Parent owned 100 percent of both subsidiary groups. Parent also had total control over the voting power of all classes of stock of the subsidiary groups. Therefore, because Parent was the common owner with total control of at least 80 percent of the total combined voting power of all classes of stock, the two subsidiary groups could be part of the same consolidated return. In addition, the lower-level subsidiaries that were part of the two groups could also be included on the same consolidated return if they meet two requirements: (i) have nexus with South Carolina; and (ii) satisfy the 80 percent control test.
Commentary
This letter ruling permits an entity to join a consolidated return as long as the "substantial control" requirement is met and the entity has income tax nexus with South Carolina. Deviating from the federal rules, the inclusion of a common parent on the return is not required. Thus, where the common parent is a foreign corporation that is not an "includible corporation" under the federal rules, the subsidiaries are not necessarily required to file separately for South Carolina income tax purposes. If they meet the substantial control requirement and have nexus with South Carolina, they can file a single state consolidated return. For some subsidiary corporations owned and controlled by a foreign corporation and doing business in South Carolina, the inclusion of a greater number of affiliates on the same return can be a counterintuitive, yet appealing option that is available to them under the state rules where it may be unavailable to them under the federal rules. It should be noted that the election to file a consolidated return must be made on an original, timely return and cannot be changed after the return is filed.7 In addition, the election must continue in effect until the Department grants permission to file separate returns.8
While the ruling is only applicable to South Carolina taxpayers, entities with this type of structure may want to consider whether different filing options may be available in other states that allow for an elective consolidation. In light of this ruling, and recent South Carolina case law developments,9 it is clear that the issue of filing methods available to South Carolina corporate tax filers has become far more complex than previously envisioned, providing taxpayers with an additional array of options and considerations.
Footnotes
1 Private Letter Ruling #12-4, South Carolina Department of Revenue, Aug. 27, 2012.
2 Under Internal Revenue Code § 1504(b), a foreign corporation is not an "includible corporation" that can be part of an affiliated group.
3 S.C. CODE ANN. § 12-6-5020(A).
4 Id.
5 S.C. CODE ANN. § 12-6-5020(B), (E).
6 S.C. CODE ANN. § 12-6-5020(D), (F).
7 S.C. CODE ANN. § 12-6-5020(G)
8 S.C. CODE ANN. § 12-6-5020(H)
9 See Media General Communications, Inc. V. Department of Revenue, 694 S.E. 2d 525 (S.C. 2010) pursuant to which a South Carolina combined report may be allowed to be filed, or required by the Department to be filed in certain circumstances.
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