The New York State Tax Appeals Tribunal has just provided timely guidance respecting the unitary business rule in New York State. In SunGard Capital Corp. and Subsidiaries (DTA Nos. 823631, 823632, 823680, 824167, and 824256, May 19, 2015), the Tribunal found that a group of related corporations were conducting a unitary business and that they should be allowed to file combined returns, reversing an administrative law judge determination.
The unitary business rules have assumed increased importance in New York this year because of recently-enacted corporate tax reform legislation. Effective January 1, 2015, the only requirements for combination in New York State and City are that the corporations must be linked by 50 percent stock ownership and must be engaged in a unitary business. It is no longer necessary for the party seeking combination (whether the taxpayer or the Department of Taxation and Finance) to show that separate filing would distort the corporations’ New York incomes.
In a related but different context, the Department’s unpublished position with respect to when an acquiring corporation and a recently purchased subsidiary can begin filing combined returns (the so-called “instant unity” issue) generally is that combined returns can be filed from the date of acquisition only if the corporations were engaged in a unitary business before they became linked by common ownership. In a recent set of questions and answers about the new law, the Department indicated that instant unitary decisions would be done on a facts-and-circumstances basis, but we understand from conversations with the Department that the existence of a unitary business between the corporations before the acquisition will be of great importance.
The SunGard case involved prior law under which distortion was an issue, but the interesting aspects of the case involve the question of whether the corporations were engaged in a unitary business, as the taxpayers contended. The corporations’ primary business involved providing information technology sales and services information, software solutions and software licensing. The administrative law judge had concluded that there were similarities among the different business segments but that the different segments operated autonomously. Although the parent provided general oversight and strategic guidance to the subsidiaries, the judge concluded that centralized management, one of the traditional criteria for a unitary business, was not present because the parent’s involvement was not operational. The centralization of certain management functions such as human resources and accounting did not involve operational income-producing activities. The judge held that holding companies, inactive companies, and companies with little or no income or expenses could not be viewed as unitary with the active companies. The judge noted that there were few cross-selling or intercompany transactions. Although programs had been developed to encourage cross-selling, they were not initiated until after the taxable years at issue.
The Tribunal reversed the administrative law judge’s decision and engaged in a detailed discussion of the elements of a unitary business that will provide useful guidance to both taxpayers and tax administrators in the future.
Although there were differences among the different segments of the group’s business, the Tribunal found that they complemented and supported each other. The Financial System (FS) business provided data processing services for customers in the financial services industry, such as investment banks, broker/dealers and insurance companies. The Public Sector (PS) business segment provided data processing services for government and non-profit entities. The Higher Education (HE) business segment provided data processing services for colleges and universities. The Availability Services (AS) business segment provided system management, business continuity, data protection, and death and disaster recovery services for customers in all sectors of the economy.
Although there were differences between the FS and the HE/PS segments with respect to specific products and services, both these segments primarily were engaged in selling software and processing services to institutional consumers, and the Tribunal found that these lines of businesses were similar for purposes of its unitary business analysis. Further, the AS segment complemented the FS and HE/PS segments by providing system management services to other members of the group. A number of the different segments had customers in common.
Centralized management was found to exist because the parent directed a group-wide cash management system pursuant to which funds were transferred from group members to other group members as needed. To the extent that these were reflected by receivables, no interest was charged. The cash management system was deemed to result in the kind of flow of value that is central to the unitary business concept. Centralized management also was shown by the parent’s responsibility for budgetary matters, its management of the group’s debt, and its role as the group’s sole contact with banks and bondholders. It also handled all central office functions, including accounting, taxes, insurance, legal, human resources and benefits. Summarizing, the Tribunal stated that the group was run “as a single business enterprise from a strategic corporate planning perspective” by officers with group-wide responsibilities. The management functions exercised by the parent were “grounded in the parent’s own operational expertise and operational strategy” and were not confined to the traditional stewardship that a parent exercises over its subsidiaries’ activities. The failure of the subsidiaries to compensate the parent for its centralized management and services was held to be a further indicator of a unitary business relationship.
The Tribunal did find, however, that there was an insufficient flow of value between the holding companies and the inactive companies to justify including them in the combined return group. The Tribunal stopped short of saying that a holding company could never be unitary with an operating subsidiary, but it said that there was no evidence in the record of the hearing indicating that the holding companies played a role in the operating companies’ activities. We have generally advised holding companies that wish to be combined with operating companies to centralize headquarters management activities in the holding company and to make sure that the holding company provides valuable services to the operating subsidiaries so as to avoid this problem.
A similar issue that was not present in SunGard is whether a holding company that is sandwiched between two operating companies that are unitary with each other will be included in the unitary group because of its position in the corporate structure. We believe that it should be and there are authorities to this effect in other jurisdictions.
Since the SunGard decision involved years under prior law, it was also necessary for the taxpayer to demonstrate that separate filing would have distorted the New York State incomes of the group members. The Tribunal found that there was sufficient distortion because the parent was not compensated for management and other services provided to the subsidiaries, noting that the Tribunal had previously held (Matter of IT US, Matter of Mohasco) that the provision of services at cost created the distortion necessary to justify combination. In SunGard, the distortion was greater because the parent did not charge the subsidiaries anything for its services.