I. INTRODUCTION - SUMMARY OF HOLDING

In Commissioner of Revenue v. The Gillette Company, 454 Mass. 72 (2009), the Supreme Judicial Court (SJC or Court) upheld the decision of the Appellate Tax Board (ATB) in favor of The Gillette Company (Gillette). At issue in Gillette was a taxpayer challenge to the Commissioner's treatment of the liquidation and merger of Gillette USA, a wholly-owned subsidiary corporation, into Gillette, its parent corporation, as a "disposition" under G.L. c. 63, § 31A(e) that triggered the recapture-related provisions [1] of the Massachusetts investment tax credit (ITC). The Commissioner's treatment had reflected the facts that the parent and its subsidiary were separate entities pursuant to Massachusetts tax law, that there was a transfer of property between these separate entities, and that there was no statutory or regulatory exception for the particular transfer at issue. The SJC, disagreeing with the Commissioner's position, reasoned that the statutory language does not compel a conclusion that the liquidation and merger in question constituted a disposition of property for purposes of § 31A, notwithstanding the separate entity status of Gillette USA and Gillette. The Court concluded that there is no "disposition" of property for purposes of § 31A where a wholly-owned subsidiary corporation is liquidated and merged into its parent corporation in a transaction qualifying as a tax-free liquidation under federal Internal Revenue Code (IRC) § 332. This Technical Information Release (TIR) discusses the Gillette decision.

II. THE INVESTMENT TAX CREDIT - G.L. c. 63, § 31A

General Laws chapter 63, section 31A allows a credit against the corporate excise tax for manufacturing corporations and business corporations engaged primarily in research and development, and corporations primarily engaged in agriculture and fishing. The amount of the credit is three percent of the cost or other basis for federal income tax purposes of qualifying property acquired, constructed, reconstructed, or erected during the taxable year. The purpose of section 31A is "to create an incentive for certain businesses to increase investment in machinery and equipment in Massachusetts so that the state's economy will be stimulated and its citizens employed." Gillette, 454 Mass. at 76. It does so by providing a tax credit equal to a portion of the cost or basis of certain kinds of property.

G.L. c. 63, § 31A(e) provides for a recapture of previously-claimed credits and for a reduction in current-year credits in the event of certain dispositions and other circumstances, specifically:

(e) With respect to property which is disposed of or ceases to be in qualified use prior to the end of the taxable year in which the credit is to be taken, the amount of the credit shall be that portion of the credit provided for in paragraph (a) which represents the ratio which the months of qualified use bear to the months of useful life. If the property on which credit has been taken is disposed of or ceases to be in qualified use prior to the end of its useful life, the difference between the credit taken and the credit allowed for actual use must be added back as additional taxes due in the year of disposition; provided however, if such property is disposed of or ceases to be in qualified use after it has been in qualified use for more than twelve consecutive years, it shall not be necessary to add back the credit , as provided in this paragraph. The amount of credit allowed for actual use shall be determined by multiplying the original credit by a ratio which the months of qualified use bear to the months of useful life. For purposes of this paragraph, useful life of property shall be the same as that used by the corporation for depreciation.

Under § 31A, if a company disposes of the qualifying property prior to the end of the taxable year in which the company claims the ITC, only a partial credit is allowed. In addition, companies that have availed themselves of the credit but dispose of qualifying property prior to the end of the property's useful life are subject to recapture, on a pro rata basis, of the ITC claimed, unless the property has been in qualified use for twelve years or more [2].

III. THE GILLETTE DECISION

In affirming the ATB's decision for Gillette, the Court held that a tax-free liquidation of a wholly-owned subsidiary into a parent corporation, resulting in a distribution of all assets owned by the subsidiary to the parent, achieved via a merger of the subsidiary into the parent, did not effect a disposition of assets for purposes of § 31A and therefore did not result in any recapture of ITC previously taken or any reduction in credits claimed for the current year.

The facts of the case were as follows. During the tax year in question, Gillette, through its subsidiaries, manufactured and sold consumer products. One of the subsidiaries was Gillette USA, which owned and operated a factory in Boston where it produced shaving products entitling it to claim ITCs against its corporate excise pursuant to G.L. c. 63, § 31A(i). In tax year 1998, Gillette acquired all of the outstanding stock of Gillette USA. During that same tax year, Gillette USA was then liquidated and merged into Gillette in a tax-free liquidation under IRC § 332. Pursuant to this event, Gillette succeeded to all of Gillette USA's assets, including the factory equipment that had generated Gillette USA's claim to the ITCs. The day-to-day operations of the shaving products factory were unaffected by the liquidation and merger, and the plant continued to operate as before.

Following an audit, the Commissioner assessed Gillette USA for unpaid corporate excise on the grounds that the liquidation and merger of Gillette USA into Gillette constituted a disposition of property qualifying for ITCs prior to the end of that property's useful life, thus subjecting Gillette USA to recapture of ITCs and reduction of current-year ITCs under G.L. c. 63, § 31A(e). The Commissioner contended that the liquidation was a "disposition" under G.L. c. 63, § 31A(e) that triggered the recapture-related provisions of § 31A(e) because the parent and subsidiary were separate entities pursuant to Massachusetts tax law, notwithstanding the fact that an IRC § 332 liquidation does not itself trigger gain or loss for federal or state income tax purposes. The Commissioner noted the absence of any statutory exception for a tax-free liquidation of a subsidiary, by contrast to federal law. The ATB disagreed, and held that an IRC § 332 liquidation was not a "disposition" within the meaning of G.L. c. 63, § 31A(e) on the facts at issue in Gillette. The SJC affirmed.

In affirming the ATB's decision, the SJC began its analysis by focusing on the relevant "statutory scheme." Gillette, 454 Mass. at 72. The Court noted that the term "disposed of" is not defined in the statute. While observing that the commonly understood meaning of "disposition" is the act of "get[ting] rid of something or the transfer of property to another", [3] the SJC concluded that the statutory language does not compel a conclusion that the merger in question constituted a disposition of property even though Gillette USA and Gillette were legally separate entities.

In the absence of statutory guidance, the Court looked to the legislative intention embodied in the statute. It noted that tax incentive statutes must be fairly construed and reasonably applied in order to effectuate the legislative intent and purpose to promote the general welfare of the Commonwealth. Id. at 76 (quoting Emhart Corp. v. State Tax Commission, 363 Mass. 429, 432). As stated by the Court in Gillette, the purpose of the Massachusetts ITC is to confer "a tax credit equal to a portion of the cost or basis of certain kinds of equipment for use in Massachusetts," thereby creating an incentive for certain businesses to locate their operations in Massachusetts and to increase investment in certain kinds of property in Massachusetts. Id.at 76. The Court noted that:

Consistent with this purpose, the recapture provisions of § 31(e) are intended to discourage companies from reneging on their end of the bargain. Companies that leave Massachusetts … by selling their qualifying property after fewer than twelve years may subject themselves to the recapture on a pro rata basis of ITCs they had claimed previously.

Id. at 76. Since the day-to-day operations of the shaving product factory were unaffected by the liquidation and merger, and the plant continued to operate, the Court concluded that requiring recapture on the facts at issue would be contrary to the purpose of the statute. Id.at 78-79.

As additional support for its position, the Court cited a settled principle of Massachusetts tax jurisprudence that tax statutes are to be construed as imposing taxes with respect to matters of substance and not with respect to mere matters of form. Id. at 77. The Court reasoned that in substance, if not in form, with respect to the property in question, Gillette was the same company as Gillette USA and was engaged in a mere continuation of Gillette USA's activities. As such, the liquidation and merger of Gillette USA into Gillette was not a disposition of the former subsidiary's assets. In these circumstances, the Court concluded, "only the form and not the facts of ownership and use" of the relevant assets has changed as a result of the merger . Id. at 79 (quoting Emhart Corp. v. State Tax Commission, 363 Mass. 429, 432) (emphasis added).

The decision in Gillette focused in particular on the property that generates the ITC. The Court's analysis was dependent on the fact that the property in question was used in the same manner by the company making use of the property - if not the same "formal" corporate owner - both before and after the liquidation and merger. The Court noted that the ITC is conferred with respect to a property's basis, and noted further that the adjusted basis of the property in the hands of the subsidiary remained the same in the hands of its parent after the liquidation and merger. Those facts led the court to conclude that there was no disposition of the property triggering the recapture-related provisions of the ITC.

Moreover, the Court found support for its decision by looking to how other states with similar ITC statutes, namely New York and Rhode Island, have addressed the same issue. Both of those states have regulations providing that the tax-free liquidation and merger of a wholly-owned subsidiary into a parent corporation does not constitute a disposition with the meaning of the relevant ITC recapture provisions. See 20 N.Y.C.R.R. § 5-2.8(e) (1998); R.I. Code R. 46 050 018-9 (2009). The Court noted also that its result was consistent with the result that would have been reached under a prior comparable federal investment tax credit provision. The Court stated that, while the Massachusetts and the prior federal investment tax credit provision were different in that federal law specifically provided an exception in these circumstances, it did not infer "an intent by the [Massachusetts] Legislature to reach a different result under our State's corporate tax laws." Id. at 79.

IV. CONCLUSION

As a result of the Gillette decision, the Commissioner will not consider the tax-free liquidation and merger of a wholly owned subsidiary into its parent, pursuant to IRC § 332, to be a disposition of assets within the meaning G.L. c. 63, § 31A(e). [4]

/s/Navjeet K. Bal
Navjeet K. Bal
Commissioner of Revenue

NKB:MTF:lbr

November 29, 2010

TIR 10-22



[1] As described below, section 31A(e) provides, in the event of certain dispositions of property and other circumstances, for (i) a reduction in ITCs claimed for the current tax year and (ii) a recapture of certain ITCs claimed in earlier tax years.

[2] The provisions of § 31A(e) also apply when property for which ITC has been taken ceases to be used in a "qualified use" prior to the end of the property's useful life.

[3] Id. at 77 (quoting from Webster's Third New Int'l Dictionary (1993)).

[4] We note that the analysis in Gillette does not extend to situations where the disposition/recapture statutory analysis does not apply. For example, see Macy's East v. Commissioner of Revenue, 441 Mass. 797 (2004) certiorari denied 543 U.S. 957 (2004) (holding that net operating loss carry forwards are extinguished when the corporation with the carry forwards is merged into another corporation); 830 CMR 63.32B.2(9) (provision in new combined reporting regulation, promulgated pursuant to G.L. c. 63, § 32B(f), stating that if a corporation with a credit carry forward liquidates or terminates as a result of a merger or consolidation, the credit carry forward will be lost); 830 CMR 63.38M.1(11) (provision in research credit regulation promulgated pursuant to G.L. c. 63, § 38M(g), stating that a research credit that belongs to one corporation is extinguished when the corporation merges into another corporation).