On October 25, 2021, the California Franchise Tax Board (“FTB”) issued a legal ruling providing guidance on the issue of when pass-through entity holding companies will be considered unitary with the pass-through entities in which they hold an ownership interest or which hold an ownership interest in them. Cal. Franchise Tax Bd., Legal Ruling No. 2021-01 (Oct. 25, 2021). California FTB legal rulings are not precedential; however, they may be cited as the FTB’s official interpretation of the tax law and courts may attribute some weight to them.
The legal ruling begins by summarizing the precedent in California relating to whether a holding company is unitary with companies in which it holds an interest, citing to various federal and state cases as well as state Board of Equalization rulings. The ruling then synthesizes the various cases and rulings, concluding that a unity determination in the context of a pass-through holding company requires “additional consideration, and may expand on a traditional unity analysis.”
Non-traditional Factors More Heavily Weighted
The ruling states that because holding companies tend to have limited (if any) operations, other non-traditional factors are more heavily weighted in determining unity. These factors include: (i) insulation from liability; (ii) acting as the focal point or conduit for ownership of an operating business; (iii) intercompany financing; (iv) shared tax benefits; (v) improved creditworthiness; (vi) covenants not to compete; and (vii) control.
Structure of Overall Business Can Be Significant
The ruling notes that the structure of the overall business can either support or not support a finding of unity. For example, the fact that a holding company functions as a conduit for its owners, or as a focal point for an operating business, supports a finding of unity while a structure of ownership that evidences an investment purpose—for example, where the holding company is not integral to the overall unitary business—supports a finding that a holding company is not unitary.
Single Business vs. Multiple Businesses
The ruling also notes that where a group of entities is engaged in a single unitary business, a holding company in that group is more likely to be unitary with the other entities in the group than where a holding company holds interests in several separate non-unitary businesses.
Majority Ownership Interest Not Required for Unity
In the case of a pass-through entity holding company, the FTB concludes a holding company can be unitary to the extent of its ownership interest in an entity and need not hold more than 50 percent of an entity in order to be unitary.
Finally, the FTB sets forth several different factual scenarios and opines on whether a pass-through entity holding company in each is unitary. As the issue of whether a holding company is unitary with other entities in its group is somewhat unsettled in many states, the FTB’s analysis of this issue may provide a useful analytical framework to taxpayers both inside and outside of California.