September 20, 2013



 

You have requested a letter ruling on behalf of your client, ************* (“Corporation X”), pertaining to the corporate relationship between Corporation X and *********** (“Corporation Y”). Your question is whether those two corporations were under common ownership pursuant to M.G.L. c. 63, § 32B(b)(2) for the period beginning ************** and ending December 10, 2012 (the “Applicable Period”) such that the two corporations were to be included in a combined group during such time for purposes of determining the income component of the Massachusetts corporate excise.  You point out that these corporations would not have been under common ownership for such period if the methodology used to determine “voting power” for purposes of the federal consolidated return rules were applied in this case.  Consequently, you inquire whether the federal consolidated return methodology applies in the context of your Massachusetts combined reporting question.

I.  Facts

The following is your representation of the facts, upon which we base this ruling.  Prior to the Applicable Period, Corporation X was wholly-owned by Corporation Y.  At the beginning of the Applicable Period, Corporation Y distributed its shares of Corporation X to its shareholders in a transaction that qualified as a tax-free spin-off (the “Spin-Off”) for federal income tax purposes under § 355 of the Internal Revenue Code of 1986, as amended (the “Code”).  During the Applicable Period, Corporation X and Corporation Y then had identical capital and governance structures.  Each had two classes of stock that held voting rights: common stock and Class B common stock.  Common stockholders were entitled to one vote per share, while Class B common stockholders were entitled to ten votes per share.  The board of directors of each company consisted of ten members, three of whom were elected solely by vote of the common stockholders, and the remaining seven of whom were elected by a combined vote of the common stockholders and the Class B common stockholders.  The organizational documents of both corporations provided for noncumulative voting in the election of directors.
 

During the Applicable Period, Corporation Y had ************* shares of common stock outstanding and *************  shares of Class B common stock outstanding, for a total of  ***************** votes.  ************* (“Shareholder”) held *********** of the *********** shares of Corporation Y common stock.  In addition, in connection with the Spin-Off, Shareholder entered into a stockholders agreement which granted Shareholder an irrevocable proxy coupled with an interest sufficient in law to support an irrevocable power over all ***************** shares of Corporation Y common stock and ************** shares of Corporation Y Class B common stock held by **************** (“Company”).  Taking the proxy into account, Shareholder held 23.13% of the Corporation Y common stock and 63.74% of the total number of Corporation Y votes.

Also during the Applicable Period, Corporation X had ************[1] shares of common stock outstanding and **************** shares of Class B common stock outstanding, for a total of ************ votes.  Shareholder held ************** of the ************* shares of Corporation X common stock.  In addition, in connection with the Spin-Off, Shareholder entered into a stockholders agreement which initially granted Shareholder an irrevocable proxy over all ************* shares of Corporation X common stock and ************* shares of Corporation X Class B common stock held by Company.  On May 3, 2012, Company sold ************ shares of Corporation X common stock, reducing Shareholder’s common stock proxy holdings to ************ shares.  Taking the proxy into account, Shareholder held 21.77% of the Corporation X common stock prior to May 3, 2012 and 13.90% thereafter, and 61.92% of the total number of Corporation X votes prior to May 3, 2012 and 56.72% thereafter.

On December 11, 2012, Shareholder’s proxy rights with respect to Company’s Corporation X common stock and Class B common stock were terminated and all voting power held by Shareholder in Corporation X was transferred to Company.

II.  Discussion of Law

Applicable Massachusetts Rules

For taxable years beginning on or after January 1, 2009, Massachusetts requires certain corporations to file a corporate excise return as a member of a combined group.  M.G.L. c. 63, § 32B.  A corporation is subject to this combined reporting requirement when it is engaged in a unitary business with one or more other corporations under common control, and it is subject to tax or would be subject to tax if doing business in the commonwealth, under M.G.L. c. 63, §§ 2, 2B, 32D, 39 or 52A.  Id.  The Massachusetts Department of Revenue (the “Department”) has promulgated rules that apply under M.G.L. c. 63, § 32B in the Combined Reporting regulation, 830 CMR 63.32B.2.

Common ownership for the purposes of M.G.L. c. 63, § 32B generally means that more than 50% of the voting control of each member of the group is directly or indirectly owned by a common owner or owners, either corporate or non-corporate, whether or not the owner or owners are members of the combined group.  830 CMR 63.32B.2(2).  In determining common ownership, the Commissioner may take into account any plan or arrangement, whether existing by operation of law, by contract, or otherwise, for bestowing or shifting ownership or voting control, in addition to the terms of any actual stock ownership or control.  Id.  The term “voting control” is not defined in either M.G.L. c. 63, § 32B or 830 CMR 63.32B.2(2), and has not been the subject of prior written guidance. 

Federal Determination of “Voting Power”

Under § 1501 of the Code, certain corporations that are members of an affiliated group may elect to file a consolidated return.  Code § 1504(a) defines an “affiliated group” generally as a chain of certain corporations that meet an 80-percent voting and value test.  The test requires, inter alia, that a parent corporation own stock in another corporation that “possesses at least 80 percent of the total voting power of the stock of such corporation.” I.R.C. § 1504(a)(2)(A).

In Revenue Ruling 69-126, the Internal Revenue Service (the “IRS”) ruled that voting power is defined primarily by the ability to elect directors to a corporation’s board.  The IRS went on to establish a mechanical test (the “Federal Test”) that looks to the power of each class of shares to elect directors, and then determines a shareholder’s proportionate amount of such power based on the number of shares of each class of stock held.  In the ruling, holders of a subsidiary’s common stock elected 5 of its 8 directors, and holders of the subsidiary’s preferred stock elected the remaining 3.  The parent corporation held 100% of the common stock and 50% of the preferred stock.  The parent therefore held [100% x 5/8] + [50% x 3/8] = 81.25% of the voting power.

In Technical Advice Memorandum 9714002 (the “TAM”), the IRS ruled that the Federal Test must be satisfied in order to meet the 80-percent voting test in § 1504(a) of the Code; effective control of a subsidiary’s board of directors achieved through the holding of noncumulative voting stock was not itself sufficient.  In the TAM, the parent corporation held 74% of the voting power as calculated using the Federal Test.  Because the subsidiary’s charter provided for noncumulative voting, however, the parent had the practical ability to elect every member of the subsidiary’s board of directors.  The IRS focused on the fact that Code § 1504(a)(2)(A) requires a parent to own “stock possessing” at least 80% of a corporation’s total voting power, and that on the facts the stock held possessed only 74% of the voting power.  As a practical matter, the IRS recognized that the minority shareholders had no ability to change the outcome in an election of directors, but concluded that the inability to change the outcome of a vote did not mean that these minority shareholders possessed no voting power.

III.  Analysis

Applying the Federal Test to the facts in this ruling, during the Applicable Period Shareholder held only 51.56% of the voting power of Corporation Y and 49.88% of the voting power of Corporation X (43.87% after May 3, 2012).  Because under the Federal Test Shareholder would not have had greater than 50% of the voting power of Corporation X, Corporation Y and Corporation X would not have been under common ownership pursuant to M.G.L. c. 63 § 32B(b)(2) for the Applicable Period if the Federal Test applied for purposes of determining common ownership.  However, the Federal Test does not apply to the facts in this case.  While the language in Code § 1504(a)(2) refers to stock that “possesses at least 80 percent of the total voting power,” M.G.L. c. 63, § 32B(b)(2) looks instead at whether “more than 50% of the voting control” of each member of the combined group is owned by a common owner or owners.  The Massachusetts rule is therefore focused on actual voting control, in contrast to the federal rule which seeks to determine the voting power held by each share of stock.

As noted above, Shareholder held greater than 50% of the total number of votes of each of Corporation Y and Corporation X during the Applicable Period.  Further, because the organizational documents of both Corporation Y and Corporation X provided for noncumulative voting, and seven of the ten directors of each company were elected by a combined vote of the common stockholders and the Class B common stockholders, Shareholder had control over the election of those seven directors regardless of the vote of any other stockholder.  On these facts, we conclude that Shareholder held more than 50% of the voting control of Corporation Y and Corporation X during the Applicable Period, and therefore Corporation Y and Corporation X were under common ownership pursuant to M.G.L. c. 63, § 32B(b)(2) during such period.

IV.  Conclusion

We conclude that Corporation X and Corporation Y were under common ownership pursuant to M.G.L. c. 63, § 32B(b)(2) for the Applicable Period.  Therefore, the two corporations were to be included in a combined group during such time for purposes of determining the income component of the Massachusetts corporate excise for each taxable member of such group.


Very truly yours,

/s/Amy Pitter

Amy Pitter
Commissioner of Revenue


AP:MTF:rf

LR 13-7


[1] As of May 3, 2012, this number had increased to ************* due to the exercise of warrants.