On September 14, the District of Columbia Office of Tax and Revenue (OTR) promulgated combined reporting regulations that are effective for tax years beginning after December 31, 2010.1 These new regulations address several combined reporting issues including the composition of the combined group, worldwide reporting election, determination of taxable income or loss, computation of net operating losses (NOLs), adoption of the Joyce rule for apportionment, treatment of partnerships, FAS 109 deduction and the automatic filing extension for the first combined return. Also, the OTR has developed a combined reporting Web site that provides additional information.

Background

In 2011, the District of Columbia enacted legislation requiring taxpayers engaged in a unitary business with one or more corporations that are part of a water's-edge combined group to file a combined report for tax years beginning after December 31, 2010.2 The OTR released proposed combined reporting regulations on January 20, 2012, but significantly revised them to reflect feedback during the 30-day comment period. On August 31, 2012, the OTR issued revised proposed regulations and allowed a seven-day comment period.3 Following the comment period, these regulations were further revised and became final on September 14, 2012.

Significant Provisions in Regulations

Some of the significant provisions contained in the final regulations are discussed below.

Composition of Group

A new regulation provides that a combined report includes all persons4 that are subject to District of Columbia corporate income tax or would be subject to tax if doing business in the District, even if they do not have nexus.5 A combined report includes, but is not limited to, any unincorporated business, financial institution, utility company, transportation company, S corporation, real estate investment trust (REIT) and regulated investment company (RIC).6 A combined report generally excludes any insurance company subject to premium tax, exempt organization, qualified high technology company (QHTC) or entity that has an average of 80 percent or more of its property, payroll and sales factors outside the U.S.7

Determination of Unitary Group

A regulation broadly interprets the term "unitary business" in line with the statute, using a flow of value test combined with a dictate that the term be construed to the broadest extent permitted by the U.S. Constitution.8 The regulation addresses when entities are commonly controlled, typically using a more than 50 percent direct or indirect ownership test.9 The regulation also provides guidance on several key terms related to the determination of the unitary group, and focuses on what constitutes a flow of value that could result in a unitary relationship.10 Finally, the regulation outlines a series of presumptions under which a unitary relationship will be found, and confirms that arm's length pricing between entities will not serve to negate evidence of a unitary relationship.11

Water's-Edge Report, Worldwide Election

In general, members of a unitary group must determine each of their apportioned shares of the combined group's net business income or loss on a water's-edge unitary combined reporting basis.12 Members of the group engaged in a unitary business may make a worldwide election to determine their apportioned share of the aggregate net income or loss from the unitary business.13 The election must be attached to an original, timely filed return and applies to the current taxable year and the following nine taxable years.14

Determination of Taxable Income or Loss

Each member of a combined group is responsible for tax based on its taxable income or loss apportioned or allocated to the District.15 A new regulation clarifies the general computation of a member's income:

  • A taxpayer's unitary business income is determined by taking the taxpayer's federal taxable income, making District adjustments and subtracting the taxpayer's nonbusiness income and the taxpayer's business income from another unitary business;
  • The total unitary business income consists of the taxpayer's unitary business income and other group members' similarly calculated unitary business income;
  • A taxpayer's District unitary business income is the total unitary business income multiplied by the taxpayer's apportionment percentage (where each factor consists of the taxpayer's District factor as the numerator, and the sum of all group members' factors in the denominator);
  • A taxpayer's District taxable income is the taxpayer's District unitary business income combined with the taxpayer's nonbusiness income allocated to the District and the taxpayer's business income from another unitary business; and
  • A taxpayer's District tax liability is the taxpayer's District taxable income multiplied by the tax rate, less the taxpayer's District tax credits.16

NOLs and Credits

A combined group member may carry forward its apportioned NOL to the extent the carryforward and offset is consistent with existing District law.17 Because the apportioned NOL carryforward is an attribute of the separate entity, a combined group member may not share its NOL carryforward with other group members or as an offset against the group's total income. The regulation also provides for the treatment of post-apportioned NOL carryforwards and includes an example of applying an NOL in a combined report.18 Similarly, a tax credit or carryforward generated by a group member may not be used by any other group member or applied against the combined group's total income.19

Joyce Position Adopted for Apportionment

A regulation clarifies that the District adopts the Joyce position.20 Therefore, each member of the combined group is treated as a separate taxpayer whose numerators will include only the taxpayer's own property, payroll and sales attributable to the District and will not include a share of a non-nexus member's factors. The regulation includes an example that illustrates the Joyce method.

Partnerships and Other Unincorporated Business (UB) Entities

In response to numerous requests during the comment process, a regulation has been created that is designed to prevent the double taxation of partnerships and other UBs.21 If the combined group includes or any member owns a UB that would be subject to the District's tax on UBs,22 the UB's income or loss is apportioned to the District using the UB's apportionment factor. The combined group member-partner's distributive share of the income,23 including separately stated items, is added to the member-partner's "other income." A member-partner's distributive share of the income that was actually taxed under the UB tax is subtracted as "other deductions" in an effort to prevent double taxation. The distributive share of the member-partner is added to the numerator and denominator of its sales factor using the UB's apportionment factor.

Income that is not taxed at the UB level is included in the combined group member partner's "other income" to the extent of its distributive share whether or not the UB is part of the combined group.24 The regulation includes specific provisions detailing the income and apportionment calculations required to account for a UB that is part of the combined group, a UB that is not part of the combined group, a partnership that is not a UB and single member limited liability companies.25

FAS 109 Deduction

If the new combined reporting requirements result in an increase to the combined group's net deferred tax liability, the combined group is entitled to a Financial Accounting Standards No. 109 (FAS 109) deduction.26 This deduction may be claimed annually over a seven-year period starting with the combined group's taxable year that begins in 2015.27

To claim this deduction, a taxpayer must file a form with the combined report by the due date for the 2012 tax return.

Combined Report Filing Extension; Revocation of Consolidated Election

In light of the late date on which the regulations have been finalized, and after much feedback from taxpayers and practitioners, an extension has been provided for combined filers for the transition year. A calendar year taxpayer that had a combined report due on September 17, 2012 is receiving an automatic extension to October 15, 2012. 28 Also, any election to file consolidated returns29 is revoked for tax years beginning after December 31, 2010.30

Closing Out Formerly Separate / Consolidated Entities

Taxpayers that filed separate or consolidated reports in the District for the tax year beginning prior to the year in which combined reporting is required for these taxpayers must file a separate zero final return with the combined report.31

OTR's Combined Reporting Web Site

The OTR has established a combined reporting Web site that provides links to the combined reporting statutes and regulations as well as the relevant forms and schedules, including detailed examples on how UBs may impact the combined group calculation.32 Also, the Web site includes a series of frequently asked questions (FAQs) expected to be updated soon, and notices issued by the OTR that relate to combined reporting.

Commentary

The regulations provide important clarity regarding the OTR's implementation of the mandatory combined reporting provisions. In particular, the regulations describe the types of entities that must be included in the combined group and the method of computing taxable income or loss. Further, the regulations require exclusion of QHTCs from the combined group, which was not addressed until the very end of the regulatory process. Also, prior to the issuance of the regulations, taxpayers were not certain whether the District was following Joyce for purposes of apportionment. The partnership and UB regulation is necessary to prevent double taxation, but the application of the regulation in the calculations on the OTR's Web site has generated a fair level of controversy throughout the development of the regulations. The FAS 109 deduction benefits taxpayers that have an increased deferred tax liability as a result of combined reporting, though taxpayers will need to estimate the FAS 109 effect well before the deduction can be taken. Finally, taxpayers have been given a much-needed extension to comply with the new combined reporting requirements, something that had been requested by many taxpayers and practitioners involved in the regulatory process.

The District's adoption of mandatory combined reporting is a major and complex change that necessitates administrative guidance from the OTR. The new regulations and the information available on the OTR's Web site provide valuable information, but the OTR most likely will provide further guidance in the future to fill in some of the gaps that still remain.

Footnotes

1 D.C. MUN. REGS. tit. 9, §§ 156 to 176. These regulations became final in the District of Columbia Register, Vol. 59 - No. 37, Sep. 14, 2012.

2 D.C. CODE ANN. § 47-1805.02a.

3 According to the OTR, "[a]mendments to the originally proposed regulations are in the nature of clarifications, examples, and additions." Also, the OTR added new regulations on real estate investment trusts (D.C. MUN. REGS. tit. 9, § 173), regulated investment companies (D.C. MUN. REGS. tit. 9, § 174) and the FAS 109 deduction (D.C. MUN. REGS. tit. 9, § 175).

4 Persons are defined as all types of entities defined in D.C. CODE ANN. § 47-1801.01(39) except for individuals. D.C. MUN. REGS. tit. 9, § 156.6(j).

5 D.C. MUN. REGS. tit. 9, § 157.2.

6 Id.

7 D.C. MUN. REGS. tit. 9, § 157.3.

8 D.C. MUN. REGS. tit. 9, § 158.1.

9 D.C. MUN. REGS. tit. 9, § 158.2.

10 D.C. MUN. REGS. tit. 9, § 158.8, .9.

11 D.C. MUN. REGS. tit. 9, § 158.11.

12 D.C. MUN. REGS. tit. 9, § 161.1. The regulation specifies the income that must be included in the report.

13 D.C. MUN. REGS. tit. 9, § 162.1.

14 D.C. MUN. REGS. tit. 9, § 162.2, .3. The election is made by the designated agent of the combined group and must indicate that every entity that is a member of the group has agreed to be bound by the election. Also, the election must include an agreement by each member of the group that the election will apply to any member that subsequently enters the group and that each member continues to be bound by the election in the event that the member is subsequently the subject of a reverse acquisition.

15 D.C. MUN. REGS. tit. 9, § 163.1.

16 D.C. MUN. REGS. tit. 9, § 163.2.

17 D.C. MUN. REGS. tit. 9, § 165.1.

18 D.C. MUN. REGS. tit. 9, § 163.2, .3.

19 D.C. MUN. REGS. tit. 9, § 166.

20 D.C. MUN. REGS. tit. 9, § 169. Many states, including states that have adopted the Uniform Division of Income for Tax Purposes Act follow the Joyce rule, a California State Board of Equalization (SBE) decision, whereby sales made to the taxing state's customers by a unitary group member that is not subject to tax in the state are not includible in the numerator of the group's sales factor in the state, even though other members of the unitary group are subject to tax in the taxing state. Appeal of Joyce Inc., Dkt. No. 66-SBE-070 (Cal. State Bd. of Equal. Nov. 23, 1966). In contrast, Finnigan is a California SBE decision, currently followed by several states, that held sales made to a taxing state's customers by a unitary group member that is not subject to tax in the state are includible in the numerator of the group's sales factor in the state, as long as at least one member of the unitary group is subject to tax in the taxing state. Appeal of Finnigan, Dkt. No. 88- SBE-022 (Cal. State Bd. of Equal. Aug. 25, 1988).

21 D.C. MUN. REGS. tit. 9, § 170.

22 See D.C. CODE ANN. § 47-1808.03.

23 "Distributive share of income" means the income reported on the federal Schedule K-1.

24 D.C. MUN. REGS. tit. 9, § 170.3.

25 D.C. MUN. REGS. tit. 9, § 170.6-.9.

26 D.C. MUN. REGS. tit. 9, § 175.

27 The annual deduction equals one-seventh of the deduction amount.

28 D.C. MUN. REGS. tit. 9, § 176.1.

29 Affiliated corporations could elect to file a consolidated return under D.C. CODE ANN. § 47- 1805.02(5)(B), (C).

30 D.C. MUN. REGS. tit. 9, § 156.5.

31 D.C. MUN. REGS. tit. 9, § 176.2.

32 This Web site may be accessed at http://otr.cfo.dc.gov/otr/cwp/view,a,1328,q,647538.asp.

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