TECHNICAL ASSISTANCE ADVISORY 96-002 SUBJECT: Method of filing for Business franchise and corporation net income taxes -- effect of changes in business organization and tax filing unit This letter is in reply to your request for issuance of a technical assistance advisory, as provided in W. Va. Code §11-10-5r, and is based upon facts submitted in support of that request. Your letter of November 21, 1995, requests a technical assistance advisory from the Tax Commissioner concluding that certain proposed changes in the business organization structure of the business group will have the following state tax effects: 1. The change in the structure of the business organization group, described below, will result in payment of essentially the same amount of West Virginia income tax after the change as before, 2. The business franchise tax will be imposed only on the net worth of the partnerships and not on the partners or on the partners' net worth, and that 3. The provision of management services to the West Virginia operating partnership by the management/service partnership will subject the management/service partnership to West Virginia nexus, but the affiliated group would escape West Virginia nexus for income tax, business franchise and sales and use tax purposes. Lastly, you request the Tax Commissioner's consent to deconsolidate West Virginia operations of the corporate group, in the future, for income and business franchise tax filing purposes in a manner similar to that described below.FACTS The material facts provided for purposes of this technical assistance advisory are as follows: Taxpayer is an out-of-state corporation which has its corporate headquarters in another state. Taxpayer is principally engaged in manufacturing, sales and distribution activity. Taxpayer has acquired a plant site in West Virginia for the purpose of constructing a facility. The facility will be constructed and equipped over a period of years at a cost of approximately X million dollars. Upon completion, the facility will be approximately Y square feet in size, and about Z individuals will be employed there. Taxpayer proposes to structure its West Virginia operations either as an operating division of Taxpayer, or to hold the operation in a wholly-owned subsidiary and elect to file on a consolidated basis for income tax purposes. Based on Taxpayer's current projections, the income and net worth apportioned to West Virginia when the facility is complete will come to slightly under twelve percent. At some point in the future, Taxpayer proposes to liquidate the division or subsidiary that holds the West Virginia operations, dropping these operations down into an operating partnership. Members of Taxpayer's affiliated group will then form a separate management and service partnership to provide general administrative, management and other business services to the West Virginia operating partnership after its formation. These services would be provided under a dual payroll arrangement, or under a separate sales agreement or other similar agreement. The partnerships would continue to have other common bonds with the affiliated. For example, employees of the partnership would be members of the same pension and welfare benefit plans as employees of the affiliated group.DISCUSSION AND ANALYSIS The request for a technical assistance advisory recognizes that the West Virginia business franchise tax and corporation net income tax laws provide that the method of filing used when making and filing the West Virginia corporate net income tax return controls how the business franchise tax return is made and filed, W. Va. Code §11-24-13a(c) (method of filing corporation net income and business franchise taxes). See also W. Va. Code §11-23-9a(c) (method of filing business franchise and corporation net income taxes). Special filing rules apply to financial organizations and to affiliated groups that include a financial organization, W. Va. Code §§11-23-5a and 11-24-7b as amended in 1996. If an election is made to file the corporation net income tax return on a consolidated basis, then the business franchise tax return must also be filed on a consolidated basis. Once an election is made to file on a consolidated basis, all members of the affiliated group must continue to file on a consolidated basis unless the Tax Commissioner consents in writing to revocation of the election, W. Va. Code §11-24-13a(b). See also W. Va. Code §11-23-9a(b). If an election is not made to file on a consolidated basis, the corporation net income tax return and the business franchise tax return must be filed on a separate corporation basis, by those corporations doing business in West Virginia. In the event the business in West Virginia is being conducted by a unitary group, the unitary group may timely petition the Tax Commissioner to file combined returns. W. Va. Code §11-23-5(p) and 11-24-7(h) (other methods of allocation and apportionment. Taxpayer proposes to structure its West Virginia operations either as an operating division of Taxpayer, or hold the operation in a wholly-owned subsidiary and elect to file on a consolidated basis for income tax purposes. In this event, the West Virginia income and franchise tax liabilities for the affiliated group would be calculated on a consolidated basis. Whether the West Virginia operation is a division of Taxpayer or is held in Taxpayer's wholly-owned subsidiary, business income and net worth will generally be apportioned to West Virginia using a four-factor formula consisting of a double weighted sales factor, a property factor and a payroll factor. Nonbusiness income is generally allocated. It appears that most of the income of the Taxpayer, and of Taxpayer's affiliated group in the event a wholly-owned subsidiary is formed, will be subject to apportionment, rather than to allocation. Based on Taxpayer's current projections, the income and net worth apportioned to West Virginia when the facility is complete will come to slightly under twelve percent. If West Virginia business franchise tax and West Virginia corporation net income tax returns are filed on a consolidated basis, West Virginia business franchise tax is paid on the consolidated capital of the affiliated group that is apportioned to West Virginia using a four-factor formula, as provided in W. Va. Code § 11-23-5, and the corporation net income tax is paid on that portion of the adjusted federal taxable income of the affiliated group that is allocated and apportioned to West Virginia as provided in W. Va. Code § 11-24-7. Nonbusiness income is allocated as provided in subsection 11-24-7(d), and business income is apportioned as provided in subsection 11-24-7(e). The statutory apportionment formula for most businesses is a four-factor formula in which the sales factor is included twice. The denominator of the formula is four unless one of the factors has no denominator. W. Va. Code §11-24-7(e). At some point in the future, Taxpayer proposes to liquidate the division or subsidiary that holds the West Virginia operations, dropping these operations down into an operating partnership. This will change the legal and operating structure of the affiliated group and will affect the relative West Virginia corporation net income and business franchise tax liabilities. This change will result from the fact that for federal and state income tax purposes a partnership is a separate legal entity and is not considered to be a member of the affiliated group. Therefore, the partnership will not be included in any future consolidated returns for federal or state purposes. For income tax purposes, the West Virginia operating partnership would not be taxed in West Virginia unless the partnership is a publicly traded partnership taxed as a corporation for federal income tax purposes. Instead, partnership income, gain, loss and deduction flow through to the partners like they do for federal income tax purposes. If the partnership does business only in West Virginia, each corporate partner's distributive share, plus or minus West Virginia adjustments, is treated as income allocated to West Virginia. If the operating partnership is doing business in West Virginia and in one or more other states, with the concomitant result that the partners are or would also be taxable in the other State or States on their respective distributive shares, then the distributive share must first be allocated, to the extent it is nonbusiness income, and the rest apportioned using the partnership's apportionment factors (as determined for business franchise tax purposes), so that only that portion fairly attributable to West Virginia is reported on the West Virginia income tax returns of the partners. Under W. Va. Code § 11-24-7(d)(5), a corporate partner pays West Virginia corporation net income tax on that portion of its distributive share which is allocated and apportioned to West Virginia as provided in subsection 11-24-7(d)(5)(B) of the West Virginia Code. When the distributive share of a corporate partner is attributable to business activity of a partnership conducted in more than one state, the business income component of the distributive share must be apportioned to West Virginia using the corporation's proportionate share of the partnership's property, payroll and sales factors, W. Va. Code § 11-24-7(d)(5)(B). As a general rule, the portion allocated and apportioned to West Virginia is treated as allocated income for West Virginia corporation net income tax purposes unless the corporate partner applies to the Tax Commissioner under subsection 11-24-7(h) for different treatment. Petitions for different treatment must be filed before the unextended due date of the West Virginia corporation net income tax return, W. Va. Code §11-24-7(h)(1)(D). A foreign corporation must pay West Virginia corporation net income tax on income it derives from a partnership doing business in West Virginia, even though the foreign corporation is not otherwise subject to West Virginia corporation net income tax. Partnerships are required to file a West Virginia Partnership Information Return, Form IT-165. A partnership must withhold West Virginia income tax on distributive shares allocated to nonresident partners as provided in W. Va. Code §11-21-71a. The rate of withholding tax is four (4) percent measured by the effectively connected taxable income of the partnership which may lawfully be taxed by West Virginia and which is allocable to a nonresident partner, whether or not such income is actually distributed. Withholding is not required when the nonresident partner timely files with the partnership a West Virginia Nonresident Income Tax Agreement, Form WV/NRW-4, in which the nonresident partner agrees to file any necessary West Virginia personal or corporation net income tax returns and pay the amount of any tax due. For West Virginia business franchise tax purposes, the operating partnership will file West Virginia business franchise tax returns and pay tax on its capital. Partners will not be required to file West Virginia business franchise tax unless a partner is otherwise doing business in West Virginia. In that event, a partner may be required to file a separate business franchise tax return and pay any tax due on its taxable net worth. If a corporate partner is otherwise doing business in West Virginia so that it is required to file a West Virginia business franchise tax return, that corporate partner may claim the credit allowed by W. Va. Code §11-23-17(c). The purpose of this credit is to avoid double taxation of a corporate partner's share of the capital of the partnership. Unless the partnership is taxable in another state, the partnership will be taxable on 100 percent of its net worth. If the partnership is taxable in another State, the partnership's net worth is apportioned using the four-factor property, payroll and sales factor in which the sales factor is double weighted, W. Va. Code §11-23-5(a). Assuming that neither the affiliated group nor the individual members of the affiliated group, including the partners holding an interest in the partnership, are otherwise doing business in West Virginia, neither the affiliated group nor the members of the affiliated group will be required to file a business franchise tax return. When the West Virginia operating partnership is formed, members of the affiliated group will form a separate management/service partnership to provide general administrative, management and other business services to the West Virginia operating partnership after its formation. These services would be provided under a dual payroll arrangement or under a separate sales agreement or other similar agreement. Both the operating partnership and the services partnership will continue to have other common bonds with the affiliated group. For example, employees of the partnerships will be members of the same pension and welfare benefit plans as employees of the affiliated group. For West Virginia business franchise tax and corporation net income tax purposes, the management services partnership and its partners would be taxed under the same rules that apply to the West Virginia operating partnership.CONCLUSIONS A. Corporation Net Income Tax REQUESTED DETERMINATION: The change in the structure of the business organization group, described above, (the future liquidation of the division or subsidiary that holds the West Virginia operations and placement of these operations into an operating partnership) would result in the payment of essentially the same amount of West Virginia income tax after the change as before, DETERMINATION: It is the determination of the Tax Commissioner that the above mentioned change in the structure of the business organization would result in the payment of West Virginia taxes after the change which would very probably not be greater than those paid prior to the change assuming that the total taxable income and total activity of the organization and the West Virginia components thereof remain approximately the same after the change as before the change. It is possible that the amount of income of the partnerships, as separate West Virginia entities after the change, may differ from the amount of the affiliated group's income allocated and apportioned to West Virginia via the four factor formula prior to the change. However, it is not expected that this would vary by a large amount. B. Business Franchise Tax REQUESTED DETERMINATION: Upon formation of the West Virginia operating partnership, business franchise tax would be assessable only on the net worth of the partnership and not on the partners or on the partners' net worth. DETERMINATION: It is the determination of the Tax Commissioner that the business franchise tax would be assessable only on the net worth of the West Virginia operating partnership and not on the partners or on the partners' net worth if the partners had no contacts with the State of West Virginia after the restructuring beyond those described above. Ownership of partnership interests in the partnership, as described herein would not create nexus between the State and the partners such as to make the partners liable for the business franchise tax. However, if the partners were engaging in business in West Virginia or otherwise had contact with the State, such as to establish business nexus with the State, then the partners might become taxable in West Virginia. The same basic treatment would apply to the management/services partnership that will engage in activity in West Virginia. C. Management and Administrative Services and Other Services REQUESTED DETERMINATION: The provision of management services to the West Virginia operating partnership by the management/service partnership would subject the management/service partnership to West Virginia nexus, but the affiliated group would escape West Virginia nexus for income tax, business franchise and sales and use tax purposes. DETERMINATION: It is the determination of the Tax Commissioner that the provision of management services to the partnership by the management/service partnership would subject the management/service partnership to West Virginia nexus. Members of the affiliated group would not have nexus with the State of West Virginia for purposes of the West Virginia business franchise tax or consumers sales and service tax unless they were otherwise doing business in West Virginia or (for business franchise tax purposes) unless the affiliated group was filing on a consolidated basis in West Virginia for corporation net income tax purposes. The partners in the management/service partnership (as well as the partners in the West Virginia operating partnership) would have a West Virginia income tax liability resulting from the partnership income allocated and apportioned to West Virginia which would flow through the partnership to the partners. If properly established, the existence of a separate partnership for management and services or dual payroll arrangement would not, in and of itself, constitute sufficient connection with West Virginia to subject the affiliated group or a member of the affiliated group to nexus in the State. For example, a sales/service employee of a member of the affiliated group who, under a dual payroll arrangement, is also an employee of the management/service partnership could perform activities in West Virginia on behalf of the management services partnership without giving the affiliated group member nexus, so long as all such activities were performed as an employee of the management/service partnership, and none of the services rendered in West Virginia by the employee are rendered as an employee of the affiliated group member. However, it is possible for a business to establish nexus with the State of West Virginia: By having a facility in West Virginia, By having more than a de minimus amount of property in West Virginia and holding or using such property in business operations in West Virginia, By engaging in ongoing business in West Virginia through employees who spend substantial time in West Virginia and make sales of products or services in the State or employees who otherwise substantially engage in business in West Virginia on behalf of their employer, or By having any other contact with West Virginia which, under the due process and commerce clauses of the United States Constitution, results in the out-of-state entity having taxable nexus with this State. Dual payroll employees would not subject the affiliated group or a member of the affiliated group to taxation by West Virginia unless activity of the dual payroll employees on behalf of the out-of-state corporate employer is more than de minimis. D. Deconsolidation REQUESTED DETERMINATION: You request the authorization of the Tax Commissioner to deconsolidate West Virginia operations of the corporate group, in the future, for income and business franchise tax filing purposes in the manner described above. DETERMINATION: It is the determination of the Tax Commissioner that the affiliated group may deconsolidate its operations in the manner described above. However, the affiliated group must inform the Tax Commissioner at least sixty days prior to liquidation or the formation of the partnership, as discussed above. The Tax Commissioner hereby authorizes such deconsolidation for corporation net income tax and business franchise tax filing purposes in accordance with the provisions and terms of this technical assistance advisory. The conclusions reached in this technical assistance advisory are based upon the facts submitted and application of current law. In the event there is a material change in the facts, or if it is determined that material facts were omitted or are materially different from those furnished to us for purposes of this ruling, or there is a material change in the applicable law, the conclusions reached in this advisory may no longer apply. Declaration of Precedential Value. -- Under W. Va. Code §11-10-5r(b), a Technical Assistance Advisory has no precedential value, except to the taxpayer who requests the advisory, unless the Tax Commissioner specifically states that it has precedential value. Due to the specialized nature of the questions presented for ruling, this Technical Assistance Advisory is declared to have no precedential value, and may not be relied upon by any person other than the specific taxpayer which requested the advisory. Publication. -- Under W. Va. Code §11-10-5r(e), the Tax Commissioner is required to release Technical Assistance Advisories to the public after they are modified to delete identifying characteristics. This advisory will be released as Technical Assistance Advisory 96-002. If you have any questions about this advisory, please contact this office. Issued April 19 , 1996. James H. Paige III Secretary\Tax Commissioner