The purpose of this TIR is to explain the Commissioner's position concerning the Appellate Tax Board's decision in Combustion Engineering, Inc. v. Commissioner, A.T.B. Docket No. F228740 (2000). Combustion pertained to a transaction in which a parent corporation sold all of its stock in a wholly-owned subsidiary to a third-party purchaser (the "Transaction") and elected pursuant to Internal Revenue Code ("IRC") § 338(h)(10) to treat the Transaction as if the subsidiary sold all of its assets directly to the purchaser. Federally, in these cases, the purchase price is allocated to the assets deemed sold by the subsidiary and the subsidiary recognizes income on the individual asset sales. In addition, the basis of the individual assets sold are "stepped up" for future federal depreciation purposes. This step-up in federal basis is also permitted for state depreciation purposes. See LR 84-45. (1)

Combustion concluded that, by virtue of the federal election, the Transaction resulted in state income to the subsidiary and not the parent since state law defines net income by reference to the Internal Revenue Code. See G.L. c. 63, § 30. However, the Board also concluded that, while the Transaction resulted in income to the subsidiary pursuant to chapter 63, the receipts from the Transaction for purposes of apportioning this income pursuant to the sales factor, G.L. c. 63, § 38(f), were attributable to the parent. As relevant, G.L. c. 63, § 38(f) provides as follows:

The sales factor is a fraction, the numerator of which is the total sales of the corporation in this commonwealth during the taxable year, and the denominator of which is the total sales of the corporation everywhere during the taxable year. As used in this subsection, "sales" means all gross receipts of the corporation except interest, dividends, and gross receipts from the maturity, redemption, sale, exchange or other disposition of securities.

Combustion reasoned that, although the Transaction was a "deemed" sale of assets for federal and state income tax purposes, this deemed sale treatment does not follow through for purposes of the sales factor apportionment provision. Consequently, the Board determined that, because the "actual" receipts from the Transaction were from the sale of securities, the sales factor receipts were attributable to the parent corporation and therefore were excluded from the parent's sales factor pursuant to the securities exemption set forth in G.L. c. 63, § 38(f). In contrast, the Commissioner had argued that the sales factor receipts that derived from the Transaction related to the subsidiary's deemed sale of assets since these were the sales that generated the relevant taxable income to be apportioned. Consequently, the Commissioner had argued that the sales factor receipts were to be included in the denominator of the subsidiary's sales factor, and would either be included or eliminated from the numerator of the subsidiary's sales factor, depending upon the location of the relevant assets. Although the taxpayer contested the Commissioner's interpretation in Combustion, this view might sometimes favor a taxpayer in the context of an IRC § 338(h)(10) election, depending upon the location of the assets.

Combustion pertained to a tax year prior to the date when the Department first promulgated its regulation position concerning the sales factor analysis applicable in the context of an IRC § 338(h)(10) election. On August 11, 1995, the Department promulgated its apportionment regulation. In that regulation, which was applied on a prospective basis, the Department announced the rule that when a parent corporation makes an IRC § 338(h)(10) election, the sales factor receipts from the transaction, like the income from the transaction, are attributed to the subsidiary. See 830 CMR 63.38.1(9)(b)7. Although this provision was not applicable in Combustion, the Board nonetheless evaluated it. The Board's conclusion was that the "[t]he regulation was neither promulgated contemporaneously with the enactment of § 38, nor is it consistent with the plain wording of the statute." ATB Docket No. F228740 at 2000-216.

In view of the Board's determination and analysis in Combustion, the Commissioner will no longer enforce 830 CMR 63.38.1(9)(b)7, as it pertains to an IRC § 338(h)(10) election. Rather, the Commissioner will hereafter treat the sales factor receipts from an IRC § 338(h)(10) transaction as belonging to the parent that sells the stock and participates in the federal election. Further, the Commissioner will recognize the Board's decision in Combustion as applicable for all open tax years, irrespective of the fact that there may have been, depending upon the timing of the transaction, a conflicting regulation in effect at the time that the transaction took place. Therefore, in any case in which a taxpayer contested the regulation and took the position that was ultimately upheld by Combustion, the Commissioner will now respect that interpretation as long as the tax year in question remains open. Further, in any case in which the regulation was in effect and the taxpayer complied with the regulation to its detriment, the Commissioner will now permit the taxpayer to rely upon this TIR to the extent that the tax year in question remains open. Finally, in any case in which the taxpayer relied upon the regulation prior to the date of the issuance of this TIR, and seeks to retain the treatment accorded to its transaction pursuant to the regulation, the Commissioner will respect this treatment. For purposes of the preceding sentence, the Commissioner will presume that a taxpayer relied upon the regulation as of the date of the transaction for which deemed sale treatment is subsequently elected.

Subsequent to the issuance of this TIR, the Commissioner will amend 830 CMR 63.38.1(9)(b)7 to comport with the analysis stated herein. From the date of the issuance of this TIR, the position stated herein shall govern and a taxpayer may no longer rely on the provisions of that regulation. (2)

/s/Bernard F. Crowley, Jr.,
Bernard F. Crowley, Jr.,
Acting Commissioner of Revenue

August 28, 2001

TIR 01-11

Footnotes:

1. Further, there is federal ITC recapture when there is a deemed asset sale under IRC § 338(h)(10), and there is similar ITC recapture for state tax purposes. See G.L. c. 63, § 31A(e). The subsidiary that recaptures the ITC may then potentially assert new ITC as to the assets acquired in the deemed purchase.

2. The Board's analysis in Combustion was interpretative of a specific statutory phrase that pertains to a particular fact circumstance as construed in the context of sales factor apportionment. See G.L. c. 63, § 38(f) (referencing, in the second sentence, "gross receipts from the maturity, redemption, sale, exchange or other disposition of securities"). The Board's analysis only applies when the issue involves the pertinent statutory language in the second sentence of § 38(f). For example, the Board's analysis does not apply when determining a corporation's property factor for apportionment purposes. See G.L. c. 63, § 38(d). Thus, when a target corporation recognizes income by reason of a Code § 338(h)(10) deemed sale of assets and has a "step-up" in asset basis as a result, this corporation must value the assets sold for property factor purposes using the property's stepped up basis. See 830 CMR 63.38.1(7)(e)iii. Further, the Board's apportionment analysis does not impact the determination of the source of income recognized by a target corporation when that corporation recognizes income by reason of a Code § 338(h)(10) deemed sale of assets. Thus, when the target corporation that engages in a 338(h)(10) sale is an S corporation, the source of the income derived from the sale is determined by the location of the assets deemed to be sold for purposes of determining the tax consequences of an individual shareholder that must report this income pursuant to chapter 62. See G.L. c. 62, § 5A.