Technical Information Release  TIR 22-14: VAS Holdings & Investments LLC v. Commissioner of Revenue: Apportionment of Gain from the Sale of a Pass-through Entity (PTE) Interest Based Entirely Upon the Attributes of the PTE

Date:	11/30/2022
Referenced Sources:	Massachusetts General Laws

I. Introduction

In VAS Holdings & Investments LLC v. Commissioner of Revenue, the Massachusetts Supreme Judicial Court (SJC) addressed the taxability of a sale of an interest in a Massachusetts pass-through entity (PTE)[1] by an S corporation not commercially domiciled in Massachusetts where the PTE was not engaged in a unitary business with the seller, and the shareholders of the seller were not actively engaged in the PTE’s business or management.  489 Mass. 669 (2022).

The SJC determined that there was no U.S. constitutional prohibition that would prevent Massachusetts from imposing tax on the apportioned gain of the seller based solely upon the factor attributes of the PTE.  See id. at 686.  However, the Court ruled that state law did not authorize the imposition of this apportioned tax. Id. This Technical Information Release (TIR) explains the Commissioner’s interpretation of VAS Holdings as it applies prospectively. It also explains the circumstances under which the Department of Revenue (the Department) will allow abatements for past periods by reason of the decision.

II. Background

In VAS Holdings, the SJC considered the taxability of gain on the sale of a fifty-percent interest in Cloud5 LLC (Cloud5), a Massachusetts limited liability company (LLC) treated as a partnership for Massachusetts tax purposes.  The interest was sold by VAS Holdings & Investments, LLC (VASHI), a Florida LLC that had elected to be treated as an S corporation.  The owners (shareholders) of VASHI were non-residents. The Cloud5 business was headquartered in Massachusetts and conducted most of its operations in the state. Neither VASHI nor its shareholders took part in Cloud5’s business operations or management either in the year of the sale or in prior years.

It was agreed by the parties that VASHI and Cloud5 were not engaged in the traditional contacts resulting in a unitary business.  See Id. at 687 n. 21; VAS Holdings & Investments, LLC. V. Commissioner, 2020 MASS. TAX LEXIS 63, at *15 (ATB 2020).  It was also agreed that the gain from the sale did not result from an investment that served an operational function such that the gain could be taxed to VASHI on a unitary basis.  2020 MASS. TAX LEXIS 63, at *15.

VASHI and its shareholders (together, the taxpayers) reported taxable gain on the sale of Cloud5.  Because VASHI did not have any tangible property, payroll or sales other than through its interest in Cloud5, and because Cloud5 had only de minimis tangible property, payroll and sales outside of Massachusetts, the taxpayers apportioned the gain to Massachusetts based solely upon the factor attributes of Cloud 5.[2]  Later, the taxpayers contested the taxability of the transaction, claiming that, because VASHI and Cloud5 were not engaged in a unitary business, apportionment based solely upon the factor attributes of Cloud5 was proscribed under the U.S. Constitution.  That contest led to the VAS Holdings litigation. 

The SJC agreed with the Department and the Appellate Tax Board that it is permissible under the U.S. Constitution for Massachusetts to impose an apportioned tax on a non-domiciliary corporation on gain derived from the sale of an interest in a PTE doing business in the state even when such gain is not includible in the unitary business income of the selling corporation, and that it is likewise permissible under the U.S. Constitution for Massachusetts to impose an apportioned tax on a non-resident individual on gain derived from the sale of such an interest even when the non-resident individual is not actively engaged in the PTE’s business or management.  See 489 Mass. at 686.  However, the Court held that the Massachusetts tax statutes do not authorize taxation in these circumstances. Id.  Therefore, the Court found in favor of the taxpayers.

III. Case Application

The Department will construe VAS Holdings as controlling with respect to the facts of the case, as noted above.  Also, the Department will apply the decision with respect to other sales of PTE interests as explained below. 

The SJC specifically noted that its holding does not apply when a non-domiciliary corporation sells an interest in a PTE and the PTE and the non-domiciliary seller are engaged in a unitary business, such that the taxable gain must be reported based on the apportionment attributes of the PTE and the seller.  Id.  Accordingly, the Department will not consider VAS Holdings to apply where a PTE and its non-domiciliary corporate owner are engaged in a unitary business, either directly or through “tiers” of PTEs.  See also M.G.L. c. 63, § 32B(b)(3). Moreover, the Department will not consider VAS Holdings to apply where the taxable gain is includible in the unitary business income of the non-domiciliary corporate seller because the investment in the PTE served an operational function with respect to the business of such seller.  See 489 Mass. at 686.  See also 2020 MASS. TAX LEXIS 63, at *15.

Further, the Department will not consider VAS Holdings to apply where the seller of the PTE interest is an individual and, though a non-resident, the individual was actively engaged in the in-state business of the PTE, either in the year of the sale or in a prior year.  In such cases Massachusetts law specifically provides that the gain is “gross income derived from or effectively connected with [a] trade or business, including any employment, carried on in the commonwealth.” M.G.L. c. 62, § 5A(a). 

Nor will the Department consider VAS Holdings to apply to gain derived by a non-domiciliary corporation or a non-resident individual from the sale of a PTE interest where the gain is not apportionable but rather allocable to Massachusetts, such as situations in which the PTE did business only in Massachusetts.  See M.G.L. c. 62, § 5A(d). 

Nor will the Department consider VAS Holdings to apply to the taxation of a PTE owner’s distributive share income derived from a PTE’s regular business operations, see 489 Mass at 673, n.5, or from the ownership or disposition of real property located in Massachusetts.  See M.G.L. c. 62, § 5A(d).

Nor will the Department consider VAS Holdings to apply to gain derived by a resident individual from the sale of a PTE interest.  An individual that is resident in Massachusetts that sells an interest in a PTE is subject to tax on 100% of his or her income, including the gain from such sale (but may be entitled to a credit for taxes paid to another state).  See M.G.L. c. 62, § 6(a).

However, the Department will consider VAS Holdings to apply to gain derived by a corporation that is commercially domiciled in Massachusetts from the sale of a PTE interest.  In such cases, if the corporate seller is engaged in a unitary business with the PTE, the gain must be apportioned using the attributes of the PTE and the seller.  If the corporate seller is not engaged in a unitary business with the PTE, such seller must allocate the gain to Massachusetts.

IV. Abatements

The Department will grant abatements based on VAS Holdings as permitted under M.G.L. chapter 62C, § 37 applying the following rules and restrictions.

An abatement may be granted to a non-domiciliary corporate taxpayer or a non-resident personal income taxpayer that reported gain from the sale of an interest in a PTE doing business in Massachusetts only if all the following criteria are satisfied.   The Department may offset the abatement by any additional tax due from the taxpayer. No such abatement will be granted to a resident individual or domiciliary corporation.

• The abatement claim must be made within the time limits set out in M.G.L. c.  62C, § 37.
• The non-domiciliary corporate taxpayer or non-resident individual taxpayer must clearly demonstrate that it apportioned the gain from the sale of the PTE interest based entirely on the PTE’s apportionment attributes.  An abatement will not be granted if the taxpayer reported the gain from the sale of the PTE interest utilizing in whole or in part the apportionment attributes of any other entity.
• Assuming that the non-domiciliary corporate taxpayer or non-resident individual taxpayer can clearly demonstrate that it apportioned the gain from the sale of the PTE interest based entirely on the PTE’s apportionment attributes, such taxpayer must also clearly demonstrate that it was proper to apportion the gain from the sale of the PTE interest without including in whole or part the apportionment attributes of any other entity. An abatement will not be granted if, for example, the PTE was engaged in a unitary business with one or more entities such that the gain should have been reported using the apportionment attributes of such entities. 
• In the case of a non-domiciliary corporate taxpayer, an abatement will not be granted where taxable gain is properly includible in the unitary business income of the taxpayer because the investment in the PTE served an operational function with respect to the business of such taxpayer.
• In the case of a non-resident individual taxpayer, an abatement will not be granted if the nonresident taxpayer was actively engaged in the in-state business of the PTE, either in the year of the sale or in a prior year. 
• An abatement will not be granted if the PTE interest was transferred in a transaction treated as sale of assets under the Internal Revenue Code (including, for example, Internal Revenue Code § 338). 
• An abatement will not be granted with respect to gain that was, or should have been, allocated entirely to Massachusetts (as opposed to being reported on an apportioned basis).  
• In no case will an abatement be granted with respect to distributive share income derived from a PTE’s regular business operations, or from a PTE’s ownership or disposition of real property located in Massachusetts.

When applying for an abatement taxpayers should follow the procedures set out in 830 CMR 62C.37.1 and TIR 16-13.   

 

                                                                                    /s/Geoffrey E. Snyder
                                                                                    Geoffrey E. Snyder
                                                                                    Commissioner of Revenue

 

GES:RHF:tjc

November 30, 2022

TIR 22-14

[1]  The seller in VAS Holdings was an S Corporation, and the interest sold was in a limited liability company taxed as a partnership.  Pass-through entities for Massachusetts purposes include S corporations, partnerships and limited liability companies that are treated as partnerships for Massachusetts tax purposes. See 830 CMR 62.5A.1(2)). 

[2] The Appellate Tax Board did not consider whether the corporations were in fact engaged in a unitary business because it concluded that the transaction was taxable in any event.  See 2020 MASS. TAX LEXIS 63, at *27.