Technical Assistance Advisory TAA 1993-003 Consumes Sales Tax

TECHNICAL ASSISTANCE ADVISORY 93-003

SUBJECT: CONSUMERS SALES TAX -- EXEMPTIONS FROMTAX -- § 11-15-9(bb) -- SERVICES FURNISHED BY ONE CORPORATIONTO ANOTHER CORPORATION WHICH IS A MEMBER OF THE SAME CONTROLLEDGROUP -- TERMS "CONTROLLED GROUP" and "OWN, DIRECTLYOR INDIRECTLY" DEFINED -- Services furnished by CorporationA to Corporation B are services furnished between members of abrother-sister controlled group when the owners of CorporationA own, directly or indirectly, 50 percent or more of the votingpower of all classes of stock of Corporation B entitled to vote,determined under constructive ownership rules of I.R.C. §§267 and 1563.

This is in reply to your request for issuance ofa technical assistance advisory, as provided in W. Va. Code §11-10-5r, based upon facts submitted in support of that request.

The question presented is whether or not ServicesCompany must collect consumers sales tax from subsidiaries ofParent Corporation on its fees to such subsidiaries for accountingand administrative services.

Your clients contend that the services providedare exempt from consumers sales tax under W. Va. Code § 11-15-9(cc),which is redesignated (bb) in Enrolled Senate Bill No. 463 enactedduring the 1993 Regular Session of the Legislature.

Section 11-15-9(bb) exempts:

(bb) ... services performed by one corporationfor another corporation when both corporations are members ofthe same controlled group. Control means ownership, directlyor indirectly, of stock possessing fifty percent or more of thetotal combined voting power of all classes of the stock of a corporationentitled to vote [or] ownership, directly or indirectly, of stockpossessing fifty percent or more of the value of the corporation.

FACTS

Parent corporation is a West Virginia corporationwith principal offices located in City, West Virginia. It has3 wholly owned subsidiaries, namely Subsidiaries A, B, and C.Additionally, Subsidiary A has a wholly-owned subsidiary.

Parent Corporation is a wholesaler of tangible personalproperty. Its 3 subsidiaries and the subsidiary of SubsidiaryA (hereinafter collectively called "Subsidiaries") engagein service business activities.

Services Company is a West Virginia corporationformed to provide services to Subsidiaries of Parent Corporation. The common stock of Services Company is owned in equal sharesby Brother A and Brother B, who also own stock of Parent Corporation.

The stock of Parent Corporation is divided intotwo classes, Class A Common Stock and Class B Common Stock, whichis owned as follows:

Class A Common Class B Common

Brother A 30 33,333

Brother B 30 33,333

Brother C 30 33,334

Mother of A, B, and C 205.5 0

Family Trust 317.5 0

The owners of the Class A Common Stock have thevoting rights, and are entitled to be paid a specified sum certainamount per share in the event of liquidation before any paymentis made to owners of the Class B Common Stock. Upon the deathof an owner of Class A Common Stock, Parent Corporation has aright to repurchase the Class A Common Stock upon payment of thesame sum certain amount per share. As long as Class A CommonStock remains outstanding, the Class B Common Stock has no votingrights. Class B dividends cannot be paid unless a Class A dividendis also paid.

Class B Common Stock is subject to a Buy-Sell Agreementwhich provides for a right of first refusal in both Parent Corporationand the remaining Class B shareholders if any of the Class B stockis to be marketed. Under the Buy-Sell Agreement the price inthe event of death, permanent disability, voluntary or involuntarytermination of the service of a Class B shareholder is based uponbook value. If any of these triggering events occur, then theClass B Common Stock must be purchased from the affected shareholdereither by Parent Corporation or by the remaining Class B shareholdersat the buy-sell formula price.

There are 1,000 shares of Class A Common Stock authorized;613 shares have been issued. There are 100,000 shares of ClassB Common Stock authorized; 100,000 shares have been issued. ClassA Common Stock has a par value of $2.00 per share; the Class BCommon Stock has a par value of $0.01 per share.

Brother C died in 19XX. His stock in Parent Corporationis still held by his estate, but will be repurchased by ParentCorporation when the estate is ready to be settled.

The Family Trust was established at the death ofthe father of Brothers A, B, and C. The life beneficiary of thattrust is their mother. At her death, the trust terminates andthe 317.5 shares of Class A Common Stock owned by the trust isdivided among the sons. Under the terms of the trust, the interestof Brother C in the remainder passes equally to Brothers A andB.

DISCUSSION

The consumers sales tax imposed by article 15, chapter11 of the West Virginia Code, applies to sales of tangible personalproperty and to the furnishing of taxable services. See W. Va.Code § 11-15-8. To prevent evasion of tax, it is "presumedthat all sales and services are subject to tax until the contraryis clearly established." W. Va. Code § 11-15-6.

W. Va. Code § 11-15-9 provides exemptions fromconsumers sales tax. Subsection 11-15-9(bb) exempts from tax:

services performed by one corporation for anothercorporation when both corporations are members of the same controlledgroup. Control means ownership, directly or indirectly, of stockpossessing fifty percent or more of the total combined votingpower of all classes of the stock of a corporation entitled tovote [or] ownership, directly or indirectly, of stock possessingfifty percent or more of the value of the corporation.

Clearly, for the subject services to be exempt fromtax under § 11-15-9(bb), the corporations for which the servicesare provided and the Services Company must all be members of thesame "controlled group of corporations."

For purposes of § 11-15-9(bb), two corporationsare members of the same controlled group when either: (1) onecorporation owns, directly or indirectly, stock possessing 50percent or more of the total combined voting power of all classesof the stock of the second corporation, which are entitled tovote; or (2) one corporation owns, directly or indirectly, stockpossessing 50 percent or more of the value of the second corporation.

Since constructive ownership of stock is permittedunder § 11-15-9(bb), two corporations are also members ofthe same controlled group when either: (1) the owners of one corporationown, directly or indirectly, stock possessing 50 percent or moreof the total combined voting power of all classes of the stockof the second corporation, which are entitled to vote; or (2)the owners of one corporation own, directly or indirectly, stockpossessing 50 percent or more of the value of the second corporation.

Unfortunately, the consumers sales tax law doesnot define the phrase "own, directly or indirectly,"or the phrase "corporations which are members of the samecontrolled group," or provide any further guidance concerninghow this exemption is to be applied.

The West Virginia Corporation Net Income Tax Act,W. Va. Code § 11-24-1 et seq., incorporates provisions offederal income tax law which define the term "controlledgroup of corporations," provide rules for determining whentwo corporations are members of the same controlled group of corporations. These rules are found in sections 267 (losses, expenses, andinterest with respect to transactions between related parties)and 1563 (definitions and special rules for limitations on certainmultiple tax benefits of certain controlled corporations) of theInternal Revenue Code of 1986, as amended.

We conclude that exemption 11-15-9(bb) should beapplied using the rules found in found in I.R.C. §§267 and 1563, to the extent they are reasonable and logicallyapplicable, for determining when two corporations are membersof the same controlled group of corporations, except that theownership percentage test to be applied is "50 percent ormore," rather than "more than 50 percent" whichis the test under § 267, or the "at least 80 percent"test under § 1563.

Under I.R.C. § 267(a) and (b)(3), no deductionis allowed in respect of any loss from the sale or exchange orproperty, directly or indirectly, between two corporations whichare members of the same controlled group (as defined in subsection(f)).

Ownership of stock in a corporation is determinedunder the constructive ownership rules set forth in I.R.C. §267(c), which read as follows:

For purposes of determining, in applying subsection(b), the ownership of stock--

(1) Stock owned, directly or indirectly, by orfor a corporation, partnership, estate, or trust shall be consideredas being proportionately owned by or for its shareholders, partners,or beneficiaries;

(2) An individual shall be considered as owningthe stock owned, directly or indirectly, by or for his family.

(3) An individual owning (otherwise than by applicationof paragraph (2)) any stock in a corporation shall be consideredas owning the stock owned, directly or indirectly, by or for hispartner;

(4) The family of an individual shall includeonly his brothers and sisters (whether by the whole or half blood),spouse, ancestors, and lineal descendants; and

(5) Stock constructively owned by a person byreason of the application of paragraph (1) shall, for the purposeof applying paragraph (1), (2), or (3), be treated as actuallyowned by such person, but stock constructively owned by an individualby reason of the application of paragraph (2) or (3) shall notbe treated as owned by him for the purpose of again applying eitherof such paragraphs in order to make another constructive ownerof such stock.

I.R.C. § 267(f) defines "controlled group"as follows:

(1) Controlled group. For purposes of thissection, the term "controlled group" has the meaninggiven to such term by section 1563(a), except that--

(A) "more than 50 percent" shall besubstituted for "at least 80 percent" each place itappears in section 1563(a), and

(B) the determination shall be made without regardto subsections (a)(4) and (e)(3)(C) of section 1563.

I.R.C. § 1563(a) defines "controlled groupof corporations" as follows:

(a) Controlled group of corporations.

For purposes of this part, the term "controlledgroup of corporations" means any group of--

(1) Parent-subsidiary controlled group. One or more chains of corporations connected through stock ownershipwith a common parent corporation if--

(A) Stock possessing at least 80 percent of thetotal combined voting power of all classes of stock entitled tovote or at least 80 percent of the total value of shares of allclasses of stock of each of the corporations, except the commonparent corporation is owned (within the meaning of subsection(d)(1)) by one or more of the other corporations; and

(B) the common parent corporation owns (withinthe meaning of subsection (d)(1)) stock possessing at least 80percent of the total combined voting power of all classes of stockentitled to vote or at least 80 percent of the total value ofshares of all classes of stock of at least one of the other corporations,excluding, in computing such voting power or value, stock owneddirectly by such other corporation.

(2) Brother-sister controlled group. Two or more corporations if 5 or fewer persons who are individuals,estates or trusts own (within the meaning of subsection (d)(2))stock possessing:

(A) at least 80 percent of the total combinedvoting power of all classes of stock entitled to vote or at least80 percent of the total value of shares of all classes of thestock of each corporation, and

(B) more than 50 percent of the total combinedvoting power of all classes of stock entitled to vote or morethan 50 percent of the total value of shares of all classes ofstock of each corporation, taking into account the stock ownershipof each such person only to the extent such stock ownership isidentical with respect to each such corporation.

(3) Combined group. Three or more corporationseach of which is a member of a group of corporations describedin paragraph (1) or (2), and one of which--

(A) is a common parent corporation included ina group of corporations described in paragraph (1), and also

(B) is included in a group of corporations describedin paragraph (2).

(4) Certain insurance companies. ***

Subsection 1563(d) provides rules for determiningstock ownership. These rules read:

(d) Rules for determining stock ownership.

(1) Parent-subsidiary controlled group. For purposes of determining whether a corporation is a memberof a parent-subsidiary controlled group of corporations withinthe meaning of subsection (a)(1), stock owned by a corporationmeans--

(A) stock owned directly by such corporation,and

(B) stock owned with the application of paragraphs(1), (2), and (3) of subsection (e).

(2) Brother-sister controlled group. For purposes of determining whether a corporation is a memberof a brother-sister controlled group of corporations (within themeaning of subsection (a)(2)), stock owned by a person who isan individual, estate, or trust means--

(A) stock owned directly by such person, and

(B) stock owned with the application of subsection(e).

Subsection 1563(e) provides constructive ownershiprules which read:

(e) Constructive ownership.

(1) Options. If any person has an optionto acquire stock, such stock shall be considered as owned by suchperson. For purposes of this paragraph, an option to acquiresuch an option, and each one of a series of such options, shallbe considered as an option to acquire such stock.

(2) Attribution from partnerships. ***

(3) Attribution from estates or trusts.

(A) Stock owned directly or indirectly, by orfor an estate or trust shall be considered as owned by any beneficiarywho has an actuarial interest of 5 percent or more in such stock,to the extent of such actuarial interest. For purposes of thissubparagraph, the actuarial interest of each beneficiary shallbe determined by assuming the maximum exercise of discretion bythe fiduciary in favor of such beneficiary and the maximum useof such stock to satisfy his rights as a beneficiary.

(B) Stock owned, directly or indirectly, by orfor any portion of a trust of which such person is consideredthe owner under subpart E of part I of subchapter J (relatingto grantors and others treated as substantial owners) shall beconsidered as owned by such person.

(C) This paragraph shall not apply to stock ownedby an employees' trust described in section 401(a) which is exemptfrom tax under section 501(a).

(4) Attribution from corporations. Stockowned, directly or indirectly, by or for a corporation shall beconsidered as owned by any person who owns (within the meaningof subsection (d)) 5 percent or more in value of the stock whichsuch person so owns bears to the value of all the stock in suchcorporation.

(5) Spouse. An individual shall be consideredas owning stock in a corporation owned, directly or indirectly,by or for his spouse (other than a spouse who is legally separatedfrom the individual under a decree of divorce whether interlocutoryor final, or a decree of separate maintenance), except in thecase of a corporation with respect to which each of the followingconditions is satisfied for its taxable year-- ***

(6) Children, grandchildren. parents, andgrandparents.

(A) Minor children. An individual shall be consideredas owning stock owned, directly or indirectly, by or for his childrenwho have not attained the age of 21 years, and if the individualhas not attained the age of 21 years, the stock owned, directlyor indirectly, by or for his parents.

(B) Adult children and grandchildren. An individualwho owns (within the meaning of subsection (d)(2), but withoutregard to his subparagraph) more than 50 percent of the totalcombined voting power of all classes of stock entitled to voteor more than 50 percent of the total value of shares of all classesof stock in a corporation shall be considered as owning the stockin such corporation owned, directly or indirectly, by or for hisparents, grandparents, grandchildren, and children who have attainedthe age of 21 years.

Subsection 1563(f) provides other definitions andspecial rules for application of section 1563. This subsectionreads as follows:

(f) Other definitions and rules.

(1) Employee defined. For purposes ofthis section the term "employee" has the same meaningsuch term is given by paragraphs (1) and (2) of section 3121(d).

(2) Operating rules.

(A) In general. Except as provided in subparagraph(B), stock constructively owned by a person by reason of the applicationof paragraph (1), (2), (3), (4), (5), or (6) of subsection (e)shall, for purposes of applying such paragraphs, be treated asactually owned by such person.

(B) Members of family. Stock constructively ownedby an individual by reason of the application of paragraph (5)or (6) of subsection (e) shall not be treated as owned by himfor purposes of again applying such paragraphs in order to makeanother constructive owner of such stock.

(3) Special rules.

(A) If stock may be considered as owned by a personunder subsection (e)(1) and under any other paragraph of subsection(e), it shall be considered as owned by him under subsection (e)(1).

(B) If stock is owned (within the meaning of subsection(d)) by two or more persons, such stock shall be considered asowned by the person whose ownership of such stock results in thecorporation being a component member of a controlled group. If by reason of the preceding sentence, a corporation would (butfor this sentence) become a component member of two controlledgroups, it shall be treated as a component member of one controlledgroup The determination as to the group of which such corporationis a component member shall be made under regulations prescribedby the Secretary which are consistent with the purposes of thispart.

(C) If stock is owned by a person within the meaningof subsection (d) and such ownership results in the corporationbeing a component member of a controlled group, such stock shallnot be treated as excluded stock under subsection (c)(2), if byreason of treating such stock as excluded stock the result isthat such corporation is not a component member of a controlledgroup of corporations.

Under the facts submitted for ruling, the ownersof Services Company directly own 60 shares of Class A Common Stockof Parent Corporation. Additionally, under the constructive ownershiprules of I.R.C. §§ 267 and 1563, they are deemed toown the 317.5 shares of Class A Common Stock owned by the FamilyTrust; the 205.5 shares of Class A stock owned by their mother;and, as heirs of the estate of Brother C, the 30 shares of ClassA stock he owned at the time of his death. Thus, the owners ofServices Company own, directly or indirectly, 100 percent of the613 shares of Class A Common Stock of Parent Corporation thatare outstanding, the only class of stock with voting power.

Upon repurchase by Parent Corporation of BrotherC's 30 shares of Class A Common Stock, the number of shares ofClass A Common Stock outstanding will reduced to 583 shares, allof which will be owned, directly or indirectly, by the ownersof Services Company.

Because the owners of Services Company satisfy thevoting power test for exemption under § 1115-9(bb),we need not consider whether they also satisfy the valuation test. These two tests are alternative tests; only one test must besatisfied to find that two corporations are members of the samecontrolled group.

CONCLUSION

When the rules of I.R.C. §§ 267 and 1563defining when two corporations are part of the same controlledgroup are applied to the facts presented for purposes of thistechnical assistance advisory, we conclude that Services Companyand Parent Corporation, including its subsidiaries, are membersof the same brother-sister controlled group, and that the ownersof Services Company own, directly or indirectly, 50 percent ormore of the total combined voting power of all classes of stockof Parent Corporation entitled to vote. Therefore, exemption 11-15-9(bb)does apply to services furnished by Services Corporation to subsidiariesof Parent Corporation.

The conclusions reached in this advisory are basedupon the facts submitted and application of current law. In theevent there is a material change in the facts, or if, upon audit,it is determined that material facts were omitted or materialfacts are different from those furnished to us for purposes ofthis advisory, or there is a material change in the law, the conclusionreached in this advisory may no longer apply.

Under W. Va. Code § 11-10-5r(e), the Tax Commissioneris required to release to the public copies of technical assistanceadvisories after they are modified to delete identifying characteristic. This advisory will be released as Technical Assistance Advisory93-003.

If you have any question about this advisory, pleasecontact this office.

James H. Paige III

Secretary/Tax Commissioner

Issued: August 17, 1993