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Ashland Inc. v. Commissioner of Revenue

Supreme Court of Minnesota

August 2, 2017

Ashland Inc. and Affiliates, Respondent,
v.
Commissioner of Revenue, Relator.

         Tax Court Office of Appellate Courts

          Walter A. Pickhardt, Faegre Baker Daniels LLP, Minneapolis, Minnesota, for respondent.

          Lori Swanson, Attorney General, Wendy S. Tien, Assistant Attorney General, Saint Paul, Minnesota, for relator.

         SYLLABUS

         1. A foreign entity's election under federal tax law to have its status as a separate entity disregarded is recognized under Minnesota tax law when calculating the "net income" of its domestic owner.

         2. Including in "net income" the income of a foreign entity that elects under federal tax law to be disregarded as a separate entity does not violate Minnesota's water's edge rule, Minn. Stat. § 290.17, subd. 4(f) (2012), because the disregarded entity does not retain a nationality separate from its owner under Minnesota tax law.

         Affirmed.

          OPINION

          HUDSON, Justice.

         At issue in this appeal from the tax court is whether the consequences of an election made under federal tax law by a foreign entity owned by respondent Ashland Inc., a domestic unitary business, must be recognized in determining Ashland's Minnesota tax liability. Concluding that the income and apportionment factors of the foreign entity were improperly included in Ashland's combined return, relator Commissioner of Revenue excluded the foreign entity's income and apportionment factors in calculating Ashland's Minnesota tax liability. The tax court disagreed with the Commissioner's conclusion and determined that the consequences of the federal election were properly included in the determination of Ashland's net income on its Minnesota tax returns. The tax court accordingly granted Ashland's motion for summary judgment. The Commissioner appealed, arguing that Minn. Stat. § 290.17, subd. 4(f) (2012), prohibits the inclusion of the foreign entity's income and apportionment factors in the calculation of Ashland's Minnesota tax liability, regardless of its treatment under federal law. We affirm.

         FACTS

         The parties have stipulated to most of the relevant facts underlying the Commissioner's appeal. Ashland Inc. is a Kentucky corporation that does business in Minnesota, among other states. In November 2008, Ashland acquired Hercules, a C corporation incorporated under the laws of Delaware. Since Ashland's acquisition of Hercules, Hercules's income has been included in Ashland's consolidated federal income tax return and in Minnesota, in the combined report required by Minnesota's unitary business principle.[1]

         Since 1999 (before Ashland's purchase), Hercules has owned 100 percent of a Luxembourg entity, Hercules SARL.[2] Treasury Regulation § 301.7701-3(a) (2012) provides that "an eligible entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner." It is undisputed that Hercules SARL is the type of eligible entity that can "elect its classification for federal tax purposes." Id. In 1999, Hercules SARL elected to be "disregarded as a separate entity, " and was therefore no longer considered "separate from its owner, " Hercules. Hercules SARL signified its election by filing Form 8832 for "Entity Classification Election" with the Internal Revenue Service (IRS) in 1999 (called "checking the box, " referring to the box on Form 8832). See Treas. Reg. § 301.7701-3(c)(1) (2012) (requiring eligible foreign entities to make their election known to the IRS via Form 8832 at the time of election). Hercules SARL's election to disregard its status as an entity separate from Hercules remained in effect during all years relevant to this appeal.

         Over the 3 tax years at issue in this appeal, Hercules SARL operated at a total net loss.[3] Because Hercules SARL elected to disregard its status as an entity separate from its owner, on its federal returns, Ashland treated Hercules SARL as a "sole proprietorship, branch, or division" of Hercules. See Treas. Reg. § 301.7701-2(a) (as amended in 2011) ("A business entity with only one owner is classified as a corporation or is disregarded; if the entity is disregarded, its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner."). Therefore, Ashland included the income, losses, and deductions of Hercules SARL for the 3 years at issue as the income, losses, and deductions of Hercules itself when it filed returns with the IRS. The Commissioner agrees that this tax-reporting treatment of Hercules SARL was proper under federal tax law.

         Ashland then prepared its combined report of the Ashland-Hercules unitary business to comply with Minnesota tax requirements. Relying on Minn. Stat. § 290.01, subd. 19 (2012), which defines net income as "federal taxable income . . . incorporating . . . any elections made by the taxpayer, " Ashland factored in the election by Hercules SARL to be disregarded as an entity separate from its owner, Hercules. Thus, in its combined report, Ashland treated Hercules SARL "in the same manner as a sole proprietorship, branch, or division of the owner, " Hercules, which itself was part of the Ashland-Hercules unitary business. See Treas. Reg. § 301.7701-2(a). The income, losses, and deductions of Hercules SARL were accordingly included as the income, losses, and deductions of Hercules on the combined report of Minnesota net income for the Ashland-Hercules unitary business.

         In February 2015, after an audit, the Commissioner determined that Ashland improperly included the income, losses, and deductions of Hercules SARL in its calculation of the Ashland-Hercules unitary business income in 2009, 2010, and 2011. The Commissioner concluded, based on Minn. Stat. § 290.17, subd. 4(f), that as a foreign entity, Hercules SARL's income and losses cannot be included in Ashland's combined report even if the entity was part of a unitary business.[4] See id. ("The net income and apportionment factors . . . of foreign corporations and other foreign entities which are part of a unitary business shall not be included in the net income or the apportionment factors of the unitary business."). After excluding Hercules SARL's income, losses, and deductions, the Commissioner recalculated the Minnesota net income of the Ashland-Hercules unitary business, and assessed Ashland with $1.167 million in additional taxes, penalties, and interest.

         Ashland appealed to the tax court. The Commissioner and Ashland filed cross motions for summary judgment. The tax court granted Ashland's motion and denied the Commissioner's motion. Ashland Inc. v. Comm'r of Revenue, No. 08819-R, 2016 WL 6635813, at *9 (Minn. T.C. June 27, 2016).

         The tax court agreed with Ashland that Minnesota's "net income" definition, Minn. Stat. § 290.01, subd. 19, required the Commissioner to "recognize the taxpayer's elections for federal income tax reporting purposes, " and thus Hercules SARL must be disregarded as an entity separate from Hercules under Minnesota tax law, just as it had been under federal law. Ashland Inc., 2016 WL 6635813, at *4-5. The tax court applied Treas. Reg. § 301.7701-3(g)(1)(iii) (2012), which provides:

If an eligible entity classified as an association elects . . . to be disregarded as an entity separate from its owner, the following is deemed to occur: The association distributes all of its assets and liabilities to ...

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