The Department of Revenue is issuing this Technical Information Release (TIR) to clarify the apportionment of income of multistate businesses to Massachusetts under G.L. c. 63, § 38, after the United States Supreme Court's decision in Allied-Signal v. Director, 112 S. Ct. 2251 (1992).
A. General Laws Chapter 63, Section 38
Domestic and foreign corporations that conduct business in Massachusetts are subject to the excise imposed by G.L. c. 63, §§ 32 and 39, respectively. A portion of this excise is based upon the corporation's income attributable to Massachusetts. In order to determine the amount of excise attributable to its income derived from business activity carried on within Massachusetts, a corporation must first calculate its "taxable net income" under G.L. c. 63, § 38(a). Then it must allocate or apportion that taxable net income to Massachusetts as provided in G.L. c. 63, § 38(b) and (c).
Under Massachusetts law, either all of a taxpayer's taxable net income is allocated to Massachusetts, or it is all apportioned. General Laws Chapter 63, Section 38, does not allocate certain items of income to Massachusetts while apportioning others. A corporation allocates all of its taxable net income to Massachusetts if it does not have income from business activity which is taxable in another state. G.L. c. 63, § 38(b). A corporation apportions all of its taxable net income if the corporation has income from business activity that is taxable both within and without Massachusetts. G.L. c. 63, § 38(c).
B. Federal Limitations on State Taxation; Unitary Business Principle
The Commerce and Due Process clauses of the United States Constitution place limits on the authority of a state to tax the income of a multistate business enterprise. W. R. Grace & Co. v. Commissioner, 378 Mass. 577 (1979). First, there must be a minimal connection or nexus between the interstate activities and the taxing state. Second, assuming that nexus is established, there must be a rational relationship between the income attributed to the taxing state and the intrastate value of the corporate business. Mobil Oil Corp. v. Commissioner of Taxes of Vermont, 445 U.S. 425 (1980); Moorman Mfg. Co. v. Bair, 437 U.S. 267 (1978).
1. Nondomiciliary Corporations
If a nondomiciliary corporation has nexus with a state because of its interstate activities, the state may impose a fairly apportioned tax on all or part of the business activities that are related to the activities carried on within its borders, whether those interstate activities are conducted through a single corporation or a group of commonly controlled corporations. The crucial inquiry is the delineation of the in-state and out-of-state activities that are sufficiently interconnected to justify apportionment. The Supreme Court has described the requisite interrelationship through the unitary business principle. Interstate activities are unitary, and therefore are taxable in all the states with which they have nexus, if there is a flow of value among the activities, as demonstrated by the presence of "functional integration," "centralization of management," and "economies of scale." F.W. Woolworth Co. v. Taxation and Revenue Department, 458 U.S. 354 (1982).
The application of unitary business principles to a particular business enterprise is inherently a factual determination. See, e.g. Container Corp. of America v. Franchise Tax Bd., 463 U.S. 159 (1983); ASARCO Inc. v. Idaho State Tax Commission, 458 U.S. 307 (1982); F.W. Woolworth Co. v. Taxation and Revenue Department, 458 U.S. 354 (1982); Exxon Corp v. Wisconsin Department of Revenue, 447 U.S. 207 (1980); Mobil Oil Corp. v. Commissioner of Taxes of Vermont, 445 U.S. 425 (1980); Becton, Dickinson & Co. v. Department of Revenue, 383 Mass. 786 (1981). When a taxpayer challenges a state's authority to apportion and tax its income, the burden is on the taxpayer to establish that the state is seeking to tax income from activities that are not unitary with the business conducted in the taxing state. Mobil Oil Corp. v. Commissioner of Taxes of Vermont, 445 U.S. 425 (1980); W. R. Grace & Co. v. Commissioner, 378 Mass. 577 (1979).
2. Domiciliary Corporations
In contrast to the rules regarding nondomiciliary corporations, a state has the constitutional authority to tax all of the non-unitary investment income of a domiciliary corporation, as well as a fairly apportioned percentage of its income from unitary business operations. See Allied-Signal v. Director, supra at 2262 (indicating a reluctance to overrule state statutes that allocate investment income to the state of commercial domicile); cf. ASARCO Inc. v. Idaho State Tax Commission, 458 U.S. 307, 346-349 (1982) (O'Connor, J., dissenting)(discussing taxation of investment income).
In Allied-Signal, the Supreme Court considered whether the state of New Jersey could require Bendix, a nondomiciliary corporation, to include in its apportionable tax base a gain that it realized on the sale of a 20.6 percent interest in the stock of ASARCO. The parties stipulated that Bendix and ASARCO were entirely unrelated business enterprises. Under this stipulation, the Court found that the operations of Bendix and ASARCO clearly were not unitary, so that apportionment of Bendix's capital gain could not be justified on that basis.
The Court acknowledged, however, that the absence of a unitary relationship between Bendix and ASARCO would not, by itself, preclude apportionment of Bendix's gain because a capital transaction involving a non-unitary payor and payee may nevertheless have an operational function. "[F]or example, a State may include within the apportionable income of a nondomiciliary corporation the interest earned on short-term deposits in a bank located in another state if that income forms part of the working capital of the corporation's unitary business, notwithstanding the absence of a unitary relationship between the corporation and the bank." Allied-Signal, 112 S. Ct. 2251, at 2263. However, the Court found under the facts presented in Allied-Signal that Bendix's holding of ASARCO stock was an investment unrelated to its business operations. The investment did not acquire an operational function even though Bendix purchased the ASARCO stock pursuant to a long-term corporate strategy of acquisitions and dispositions, and even though Bendix intended to use gain from the stock sale to finance the purchase of another corporation that would have operated as part of Bendix's unitary business. Because Bendix and ASARCO were not unitary, and because Bendix's acquisition of ASARCO stock did not have an operational function, the Court held that New Jersey could not apportion the gain on the sale of ASARCO stock.
D. Effect of Allied-Signal on Massachusetts Law
The literal application of the "full apportionment" principles of G.L. c. 63, § 38, to nondomiciliary corporations may encounter the jurisdictional limitations enunciated by the Supreme Court in situations where a nondomiciliary corporation has income from an investment that is unrelated to any business it conducts in Massachusetts. It does not appear that the Legislature intended to impose tax on activities that are beyond the state's jurisdiction when it adopted G.L. c. 63, § 38. Accordingly, the Department will apply the statute in a manner that conforms with federal law, as described below.
A nondomiciliary corporation or other nondomiciliary entity engaged in interstate business and subject to apportionment under G.L. c. 63, § 38, must exclude from its taxable net income any item of income (or loss) from the holding or disposition of securities if Massachusetts does not have jurisdiction under the United States constitution to tax such item of income. Under the principles enunciated in Allied-Signal, such income is properly excluded if: (1) the relationship between the taxpayer and the business represented by the security is not unitary; and (2) the acquisition and holding of the security does not otherwise have an operational function, such as (but not limited to) the short-term investment of working capital. If a taxpayer claims that one or more items of its income are not subject to Massachusetts tax jurisdiction and are therefore not apportionable, the taxpayer must disclose its claim on its return and must bear the burden of proving its claim. A nondomiciliary taxpayer should not file an application under G.L. c. 63, § 42, to claim the exclusion allowed under this TIR.
Commissioner of Revenue
October 9, 1992