TECHNICAL ASSISTANCE ADVISORY 95-004Subject: Technical Assistance Advisory Related to Unitary Filing for an Affiliated Group This Technical Assistance Advisory is issued in reply to a request for a Technical Assistance Advisory, as provided in W. Va. Code §11-10-5r, and is based upon facts submitted in support of the said request. The Taxpayer requested a Technical Assistance Advisory from the Department of Tax and Revenue enabling the Taxpayer and certain members of its affiliated group to file on a unitary basis for the West Virginia business franchise tax and for the West Virginia corporation net income tax.FACTS For its (fiscal) tax year ending in 1994, the Taxpayer and its wholly owned subsidiaries were members of an affiliated group and will file a consolidated federal income tax return. For that taxable year, these companies will also file consolidated West Virginia corporation net income tax and business franchise tax returns. During the tax year ending in 1995, a member of the consolidated group should, for the first time, derive more than 50% of its gross income from installment obligations and other activities consisting of making, acquiring, selling or servicing loans or extensions of credit. As a consequence of this fact, that group member will meet the definition of a financial organization set forth in Section 11-23-3(b)(13)(C) of the West Virginia Code, and Section 11-24-3a(10)(C) of the West Virginia Code. That group member is domiciled in a state other than West Virginia, and is therefore prohibited from joining in the filing of the consolidated West Virginia corporation net income tax and business franchise tax returns for the 1995 fiscal year under Sections 11-24-7b(c) and 11-23-5a(c) of the West Virginia Code. The remaining members of the affiliated group are precluded from continuing to file a West Virginia consolidated return based upon Section 11-24-13a. Except for several companies specifically named in the Taxpayer's request for a Technical Assistance Advisory (herein designated Excluded Companies), each member of the affiliated group contributes to or is dependant upon other affiliated members. Significant intercompany sales and other transactions occur routinely, and the unitary companies are commonly owned and are engaged in the same general, vertically integrated, line of business. The Excluded Companies are not engaged in the same general line of business as the remaining members of the group, and are not part of the functionally integrated group of affiliated corporations as defined in 110 C.S.R. Series 24, § 7.24.4.2.f. The Taxpayer requests a ruling that, for purposes of filing West Virginia corporation net income tax returns and business franchise tax returns, for tax years ending in 1995, and thereafter, the affiliated group is authorized by the Department of Tax and Revenue to file its tax returns on the following basis: (1) A single combined corporation net income tax and a single combined business franchise tax return will be filed for the group included on the 1994 income tax return, with inclusion of all other new members of the affiliated group engaged in the same general, vertically integrated line of business with the exception of the Excluded Companies, the net income and capital of which will be excluded from the combined returns. (2) To the extent that the Excluded Companies have nexus with West Virginia, each company having nexus shall file West Virginia corporation net income tax and business franchise tax returns on a separate company basis and adhere to the requirements of Sections 11-24-7b and 11-23-5a, to the extent applicable. DISCUSSION AND ANALYSIS Section 110-24-7.24 et seq. of the Code of State Regulations sets forth the requirements for use of a method of allocation and apportionment of corporation net income other than the four factor formula prescribed by Section 11-24-7 of the West Virginia Code. Section 110-24-7.24.1 states that: If the allocation and apportionment provisions of W. Va. Code §§11-24-7(d) and (e) do not fairly represent the extent of the taxpayer's business activities in this State, the taxpayer may petition for, or the Tax Commissioner may require, in respect to all or any part of the taxpayer's business activities, if reasonable: (1) separate accounting; (2) exclusion of one or more of the factors; (3) inclusion of one or more additional factors which will fairly represent the taxpayer's business activity in this State; or (4) the employment of any other method, including a unitary basis, to effectuate an equitable allocation or apportionment of the taxpayer's income. Emphasis added. This language closely reflects the language of Section 11-24-7(h) of the West Virginia Code. Section 11-24-7a(a) of the West Virginia Code provides, in relevant part: Permission granted to a taxpayer under subsection (h), section seven of this article to use another method of allocation or apportionment shall be valid for a period of five consecutive taxable years, beginning with the taxable year for which such authorization is granted, provided there is no material change of fact or law which materially affects the fairness and reasonableness of the result reached under such other method of allocation or apportionment. Upon expiration of any such authorization the taxpayer may again petition under section seven of this article to use another method of apportionment. A material change of fact or law which materially affects the fairness and reasonableness of the result reached under such other method of allocation or apportionment automatically revokes authorization to use that other method beginning with the taxable year in which the material change of fact occurred or the taxable year for which a material change in law first takes effect, whichever occurs first. Section 110-24-7.24.2 prescribes the required application process for requesting an alternative method: 7.24.2. In order for a taxpayer to request an alternative method of allocation and apportionment, or of allocation or apportionment, a taxpayer shall do so by filing a petition. This petition shall be filed no later than the due date of the annual return for the taxable year for which the alternative method is requested, determined without regard to any extension of time for filing such return, and the petition shall include a statement of the petitioner's objections to the statutory method of allocation and apportionment or of allocation or apportionment and a statement of the alternative method of allocation or apportionment as it believes to be proper under the circumstances with such detail and proof as the Tax Commissioner may require. Section 110-24-7.24.4 of the regulations discusses unitary filing methods: 7.24.4. Unitary methods. 7.24.4.1. A taxpayer may request to file on a unitary basis in accordance with the rules set forth herein. 7.24.4.2. Determination of a Unitary or Separate Business. 7.24.4.2.a. A corporation subject to taxation may be engaged in more than one "trade or business." In such cases, it is necessary to determine the business income attributable to each separate trade or business. The income of each business is then apportioned by a formula which takes into consideration the in state and out-of-state factors which relate to the respective trade or business subject to apportionment. 7.24.4.2.b. In addition, a corporation may be engaged in a single trade or business in combination with another commonly owned and controlled corporation or corporations. In such cases, it is necessary to determine the total business income of all such corporations attributable to the single trade or business. The combined income of the single trade or business is then apportioned by formula which takes into consideration the in-state and out-of-state factors of each corporation which relate to that single trade or business. 7.24.4.2.c. When business segments of a single corporation or the business activities of more than one corporation constitute a single trade or business, such single trade or business is said to constitute a "unitary business." 7.24.4.2.d. A unitary business exists when the operations of the business segments of a corporation or group of commonly owned and controlled corporations contribute to or depend on each other in such a way as to result in functional integration between such segments. Functional integration refers to transfers between or pooling among business segments of such items as products or services, technical information, marketing information, distribution systems, purchasing and intangibles (such as patents, copyrights, formulas, processes, trade secrets, and the like) in a manner which substantially affects the segments' business operations related to such activities as development, manufacture, production, extraction, distribution, or sale of its products or services. 7.24.4.2.e. Evidence of functionally integrating factors. -- The determination of whether or not the operations of business segments are functionally integrated will turn on the facts and circumstances of the case. Several factors may evidence that the operations of business segments are functionally integrated. A non-exclusive list of such factors is found below in paragraph 7.24.4.2.f of this Subsection. Generally, several functionally integrating factors will exist in a unitary business, although a unitary business may exist as a result of few factors or even one factor, if the factor or factors involved are particularly significant. In determining whether a unitary business exists factors should not be examined in isolation. Instead, it should be determined whether the factors which are present, in combination, result in a functionally integrated business. In addition, the presence or absence of any one factor or any particular factors is not necessarily determinative as to whether a unitary business exists, although absence of all of the factors described by subparagraphs 7.24.4.2.f.1 through 7.24.4.2.f.5 of paragraph 7.24.4.2.f of this Subsection will generally result in a finding that a unitary business does not exist. 7.24.4.2.f. Functionally integrating factors. -- A non-exclusive listing of factors to be considered in determining whether business segments are functionally integrated appears below. 7.24.4.2.f.1. Intercompany sales, exchanges, or transfers. 7.24.4.2.f.1.a. Sales, exchanges, or transfers (hereinafter "sales") of products services, intangibles or the like between business segments are important indicia of functional integration. The significance of intercompany sales will be a function of both the character of the items sold and percentage of total sales or purchases represented by the intercompany sales. Intercompany sales at a given level take on greater significance if there is a limited sales or purchasing market for such items or if valuable trade name or other intangibles are associated with such sales, or both. . . . 7.24.4.2.f.1.d. Sales exchanges or transfers between business segments may be disregarded where intercompany sales are used as a device to assert unitary combination for tax avoidance purposes. 7.24.4.2.f.2. Common marketing. 7.24.4.2.f.2.a. When business segments share substantial common marketing features, such features can be an important characteristic of functional integration when such marketing results in significant mutual advantage. For this purpose, common marketing exists when a substantial portion of the business segments' products, services, intangibles, or the like are distributed or sold to a common customer, or the business segments use a common trade name or other common identification and such common identification is a significant factor in purchasers' decisions to purchase the respective products or services. . . . 7.24.4.2.f.3. Transfer or pooling of technical information. -- Evidence of functional integration may be indicated by transfers or pooling of technical information, know-how, or research and development, if such transfer or pooling represents a significant economy of scale or the information shared is particularly important to the segments' operations. 7.24.4.2.f.4. Common distribution system. -- Business segments may demonstrate evidence of functional integration by use of a common distribution system, under which inventory control and accounting, storage, trafficking and transportation are controlled through a common network. 7.24.4.2.f.5. Common purchasing. -- Evidence of functional integration may be indicated by common purchasing of substantial quantities of products, services, intangibles, or the like from the same source, where such purchasing results in a significant economy of scale, or where such products, services, intangibles, or the like are not readily available from other sources and are particularly important to each segment's operations or sales. 7.24.4.2.f.6. Centralized management. 7.24.4.2.f.6.a. Centralization of management exists when directors, officers and/or management employees jointly participate in management decisions which significantly affect the respective business segments. Transfer of officers or management employees between business segments may also provide evidence of centralization of management. . . . 7.24.4.2.f.7. Other factors. -- Functional integration of business segments will generally not be evidenced by such factors (alone or in combination with other factors described by this subparagraph) as common or intercompany financing (other than between financial institutions), advertising (in the absence of common marketing described by subparagraph 7.24.4.2.f.2 of this paragraph), labor relations, warehousing (in the absence of a central distribution system described by subparagraph 7.24.4.2.f.4 of this paragraph), pension plans, insurance, and personnel recruitment. However, where a factor or factors described by subparagraphs 7.24.4.2.f.1 through 7.24.4.2.f.5 of this paragraph do not clearly demonstrate that functional integration exists, the factor or factors described in this subparagraph may, in combination with the factors described in subparagraphs 7.24.4.2.f.1 through 7.24.4.2.f.5 of this paragraph, demonstrate sufficient additional evidence of functional integration to warrant a finding that a unitary business exists. 7.24.4.2.f.8. Factors accorded little weight. -- Factors such as common legal services, accounting, tax administration, and financial reporting will generally be accorded little weight in the determination of whether business segments are functionally integrated. 7.24.4.2.g. The presence of a unitary business will be presumptively shown by the presence of the following: 7.24.4.2.g.1. Same general line of business: There is a strong presumption that a corporation or a commonly owned and controlled group of corporations is engaged in a unitary business when its activities are in the same general line. For example, a corporation which operates a chain of retail grocery stores will almost always be engaged in a unitary business. 7.24.4.2.g.2. Steps in a vertical process: A corporation or a commonly owned or controlled group of corporations is almost always engaged in a unitary business when its various divisions or segments are engaged in different steps in a vertically structured enterprise. For example, a corporation which explores for and mines copper ores; concentrates, smelts and refines the copper ores; fabricates the refined copper into consumer products and distributes such products (whether by intercompany fee or purchase, or without charge) is engaged in a unitary business, regardless of the fact that the various steps in the process are operated substantially independently of each other with only general supervision from the corporation's executive offices. 7.24.4.2.h. Business segments which are neither in the same general line nor steps in a vertical process are presumptively engaged in separate businesses, absent a determination that the respective segments are functionally integrated. 7.24.4.2.i. In the event that a business segment is functionally integrated with a second business segment and the second business segment is functionally integrated with a third business segment, the first, second and third business segments constitute a unitary business notwithstanding the fact that the first and third business segments are not functionally integrated with each other. The preceding sentence shall not apply where the second business segment's functional integration is not substantial viewed from the perspective of either the first or third business segment. . . . 7.24.4.2.j. Where the taxpayer asserts that business segments are unitary, the taxpayer shall have the burden of proof. Failure by the taxpayer to produce requested evidence which lies within the control of the taxpayer gives rise to a presumption that the evidence would be unfavorable if provided. In essence, the regulations set forth six factors which indicate the existence of a unitary business, and the regulations allow for the existence of other factors. The regulations specifically describe the following items: (1) Intercompany sales, exchanges, or transfers. (2) Common marketing. (3) Transfer or pooling of technical information. (4) Common distribution system (5) Common purchasing (6) Centralized management. (7) Other factors. In addition to these seven items, Section 7.24.4.2.g of the above quoted regulations sets forth a presumption that a unitary business exists upon a showing that: (1) The controlled group is engaged in the same general line of business, or (2) The controlled group members are engaged in different steps in a vertically structured enterprise. Significant intercompany sales and other transactions occur routinely. The Taxpayer's request for a Technical Assistance Advisory is silent as to whether the companies have centralized management, or common marketing, distribution, or purchasing, and is silent as to whether the companies transfer or pool technical information. However, the unitary companies are commonly owned and are engaged in the same general, vertically integrated, line of business. CONCLUSION The Department of Tax and Revenue will allow the Taxpayer and the aforesaid unitary group to adopt a unitary filing method. The existence of a group of affiliated companies engaged in the same general, vertically integrated, line of business presumptively establishes the existence of a unitary group. In addition, deconsolidation of the filing unit is required under the financial organizations provisions of Sections 11-23-5a and 11-24-7b of the West Virginia Code. Unitary filing would appear to be an appropriate and logical alternative filing method given the mandated deconsolidation. The Taxpayer's requested ruling is granted. For purposes of filing West Virginia corporation net income tax returns and business franchise tax returns, for tax years ending in 1995, and thereafter, the Taxpayer's affiliated group is hereby authorized by the Department of Tax and Revenue to file its tax returns on the following basis: (1) A single combined corporation net income tax and a single combined business franchise tax return will be filed for the group of affiliated companies which was included on the 1994 income tax return, with inclusion of all other new members of the affiliated group engaged in the same general, vertically integrated line of business with the exception of the Excluded Companies, the net income and capital of which will be excluded from the combined returns. (2) To the extent that the Excluded Companies have nexus with West Virginia, each company having nexus shall file West Virginia corporation net income tax and business franchise tax returns on a separate company basis and adhere to the requirements of Sections 11-24-7b and 11-23-5a, to the extent applicable. Pursuant to the requirements of Section 11-24-7a(a) of the West Virginia Code, this authorization to use the unitary filing method and the method authorized for the Excluded Companies shall be valid for a period of five consecutive taxable years, beginning with the taxable year for which such authorization is granted, provided there is no material change of fact or law which materially affects the fairness and reasonableness of the result reached under such methods. Upon expiration of this authorization, the taxpayer may again petition under Section 11-24-7 of the West Virginia Code to use an alternative method of apportionment. A material change of fact or law which materially affects the fairness and reasonableness of the result reached under the unitary filing method and the method prescribed for the Excluded Companies authorized herein shall operate to automatically revoke authorization to use such methods beginning with the taxable year in which the material change of fact occurred or the taxable year for which a material change in law first takes effect, whichever occurs first. 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 question 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 95-004.Issued September 20, 1995 James H. Paige III Secretary/Tax Commissioner