Is a corporation's gain from selling its LLC interest business income, and is that gain (or the LLC's sales) included in the Colorado apportionment factor?
Plain-English summary
A corporation that runs two independent manufacturing divisions — one in Colorado (energy industry) and one in Illinois (aerospace) — sold a 50% interest in a Delaware LLC it had formed to hold Illinois-division contracts. The corporation is treated as commercially domiciled in Colorado (most officers there). It asked three questions about the gain from that sale, and the Department answered each:
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Is the gain "business income"? — Yes. The LLC interest is intangible property that the corporation used in its trade or business, and Colorado presumes corporate income is business income "unless clearly classifiable as nonbusiness income." On top of that, a corporation can simply elect to treat all its income as business income (§ 39-22-303.5(6)). So the gain is business income, which means it's apportioned, not allocated to a single state.
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Does the corporation include the LLC's gross sales in its Colorado factor? — Yes. A partner is generally deemed to conduct the partnership's business directly, so the corporation's distributive share of the LLC's gross sales are its own gross sales for the sales factor (to the extent that pass-through income is business income).
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Is the gain itself included in the apportionment factor? — No, it's excluded. Normally, gain from the sale of intangible property is sourced to Colorado and put in the numerator of the sales factor when the taxpayer's commercial domicile is in Colorado (§ 39-22-303.5(4)(c)(V)). But here, all the accounting, financial, payroll, engineering, manufacturing, and distribution work behind the gain happened in Illinois, and the LLC made no sales into Colorado. Sourcing the whole gain to Colorado on commercial-domicile grounds would "produce incongruous results" and not fairly represent the corporation's Colorado activity. So the Department invoked alternative (equitable) apportionment under § 39-22-303.5(7)(b)(III) to disregard the gain in the sales factor.
The takeaway: being business income (so it's apportionable) is a separate question from whether it belongs in the apportionment factor. The gain stays apportionable income, but it's pulled out of the factor because including it would distort the result. As a PLR, this binds the Department only for this taxpayer.
This is the same three-issue structure — and the same outcome — as [[plr-16-015-acquisition-and-restructuring-transaction]]. It also belongs to the broader "in the income but not in the factor" thread alongside [[plr-26-002-receipts-for-income-apportionment]] and [[plr-23-002-exclusion-of-gain-from-apportionment-factor]], though those two reached exclusion through the "not a regular-course receipt" route rather than through equitable apportionment.
What this means for you
Multistate corporations selling LLC or partnership interests
A gain can be apportionable business income and still be kept out of your Colorado sales factor when the activity that generated it sits in another state. Don't assume your commercial domicile automatically drags the whole gain into Colorado — if the underlying operations are elsewhere, equitable apportionment under § 39-22-303.5(7)(b)(III) can be the tool to disregard the gain. Expect to support it with facts about where the work actually happened.
Corporations with pass-through (LLC/partnership) income
Your distributive share of the entity's gross sales flows into your own sales factor when that income is business income — the partner is treated as conducting the business directly. The gain on selling the interest is a different item and may be handled separately.
Accountants and tax professionals
Three distinct determinations: (1) business vs. nonbusiness income (presumption + § 303.5(6) election); (2) inclusion of the entity's gross sales in the factor; (3) whether the gain itself is sourced into the factor or disregarded via § 303.5(7)(b)(III). Alternative apportionment is for "unique and nonrecurring" situations where the standard rules "produce incongruous results."
Common questions
Q: Is gain from selling an LLC interest business income in Colorado?
A: On these facts, yes — the interest was intangible property used in the corporation's trade or business, and a corporation can also elect to treat all income as business income.
Q: If the gain is business income, is it automatically in the Colorado apportionment factor?
A: No. Business income is apportionable, but the Department excluded this gain from the sales factor because sourcing it to Colorado by commercial domicile would be distortive when the operations were in Illinois.
Q: What rule lets the Department exclude the gain?
A: Alternative or equitable apportionment under § 39-22-303.5(7)(b)(III), used in limited, nonrecurring cases where the normal rules would produce incongruous results.
Q: Can my business rely on this ruling?
A: No. A private letter ruling binds the Department only for the taxpayer and facts it was issued to and cannot be relied upon by anyone else.
Citations and references
Statutes, rules, and authorities:
- § 39-22-303.5(1)(a), (c), C.R.S. (business/nonbusiness income; presumption of business income)
- § 39-22-303.5(6), C.R.S. (election to treat all income as business income)
- § 39-22-303.5(4), C.R.S. (single-sales-factor apportionment); (4)(c)(V) (gain from intangibles sourced to commercial domicile)
- § 39-22-303.5(7)(b)(III), C.R.S. (alternative / equitable apportionment)
- 1 CCR 201-2, Rules 39-22-303.5.1, 303.5.4, 303.5.7 (apportionment regulations)
- 26 U.S.C. § 702 (partner's distributive share of partnership gross income)
- 1 CCR 201-1, Rule 24-35-103.5 (private letter ruling procedure)
Source
- Landing page: https://tax.colorado.gov/all-letter-rulings
- Original PDF: https://tax.colorado.gov/sites/tax/files/documents/PLR-17-009.pdf
Original ruling text
Office of Tax Policy
P.O. Box 17087
Denver, CO 80217-0087
[email protected]
PLR-17-009
December 29, 2017
XXXXXX
Attn: XXXXXX
XXXXXX
XXXXXX
Re: Treatment of Gain Realized from the Sale of Ownership Interest in an LLC
Dear XXXXXX,
You submitted a request for a private letter ruling on behalf of XXXXXX (“Company A”)
to the Colorado Department of Revenue (“Department”) pursuant to Department Rule
24-35-103.5. This letter is the Department’s private letter ruling. This ruling is binding
on the Department to the extent set forth in Department Rule 24-35-103.5. It cannot be
relied upon by any taxpayer other than the taxpayer for whom the ruling is made.
Issues
1. Is the gain realized by Company A from the sale of its interest in the limited
liability company considered business income?
2. Should Company A include its distributive share of the limited liability
company’s gross sales in its Colorado apportionment factor?
3. Should the gain Company A realized from the sale of its interest in the
limited liability company be excluded from its Colorado apportionment
factor?
Conclusion
1. Based on the facts presented, the gain Company A realized from the sale
of its interest in the limited liability company is business income.
2. Based on the facts presented, Company A should include its distributive
share of the limited liability company’s gross sales in its Colorado
apportionment factor.
3. Based on the facts presented, Company A should exclude the gain it
received from the sale of its interest in the limited liability company from its
Colorado apportionment factor.
Background
According to the facts presented, XXXXXX operates two separate and distinct
manufacturing divisions: one division in Colorado (“Colorado Division”) and another
division in Illinois (“Illinois Division”). Both divisions function independently, with
separate executive management, accounting, engineering, purchasing, marketing,
manufacturing, distribution, and human resource operations. The Illinois Division
manufactures and sells products in the aerospace industry, while the Colorado
Division manufactures and sells products in the energy industry. Company A
appears to be commercially domiciled in Colorado as most of its corporate officers
are located in Colorado. But, as described above, all of Illinois Division’s operational
management is in Illinois. For the purpose of this letter, we assume that Company A
is commercially domiciled in Colorado.
Company A and an unrelated company (“Company B”) entered into a joint venture,
whereby the joint venture, either directly or through Company A or Company B,
provides varying support for the fuel system requirements on Company B’s engines.
After the establishment of the joint venture, Company A and the joint venture
entered into a supply agreement pursuant to which Company A provides the joint
venture with fuel system components at its direct product cost plus an overhead
rate.
In August 2015, Company A formed, as the sole member, a new Delaware limited
liability company, XXXXXX (“LLC I”), which is treated for tax purposes as a
partnership. Immediately thereafter, Company A contributed to LLC I certain
contracts between Illinois Division and Company B relating entirely to Illinois
Division’s business of providing fuel system components for Company B’s engines.
All of the activities related to these contracts performed by Company A are solely
related to the activities of the Illinois Division.
On the same day, after contributing the contracts to LLC I, Company A formed a
second new Delaware limited liability company, XXXXXX (“LLC II”), which is treated
for tax purposes as a C corporation. Company A then contributed a 10% ownership
interest in LLC I to LLC II.
Company B expressed a desire to purchase an interest in LLC I and, in January of
2016, following negotiations led by Illinois Division, Company A sold a 50% interest
in LLC I to Company B for cash and contingent consideration in the form of an
annual payment for each of the 15 years following closing. LLC I made an election
under section 754 of the Internal Revenue Code with respect to such purchase to
step up the basis in the partnership property (the contracts contributed to LLC I by
Company A) as it relates to the purchased portion. After this transaction, LLC I was
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owned 40% by Company A, 10% by LLC II and 50% by Company B. All income,
losses, and distributions are shared in accordance with these ownership
percentages.
LLC I does not have any direct common-law employees, but approximately 10
people from both Illinois Division and Company B are working on behalf of LLC I
through a secondment agreement. Among the employees from Illinois Division and
Company B working on behalf of LLC I are a Finance Manager and General
Manager, both of whom are located in Illinois. Additionally, all other employees
working on behalf of LLC I from Illinois Division are also located in Illinois. The other
employees from Company B working on behalf of LLC I are located in Ohio. The law
firm working on the legal aspects of LLC I is located in California.
All products manufactured by Company A for the fulfillment of the LLC I supply
agreement are manufactured in and shipped from Illinois Division. Also located at
this location in Illinois are the accounting, financial, payroll, engineering,
manufacturing, and distribution departments that account for and manage its
business activities. The local management team’s titles at this location include
President, Vice President of Finance, Sales & Marketing Head, and Manufacturing
Head. Other than some limited corporate oversight, all of Illinois Division’s business
activities are managed, accounted for, and directed by the local management team.
Since its inception, LLC I has made sales to customers and has shipped products to
destinations in a limited number of states, none of which were in Colorado. In
addition, LLC I has foreign sales that also have no relationship to Colorado.
Company A will recognize a gain (“the Gain”) for income tax purposes from the sale
of the 50% partnership interest in LLC I to Company B. Company A will report the
Gain as apportionable business income in all states where it files income tax returns
for its fiscal tax year ending September 30, 2016. For state apportionment purposes,
Company A expects the net gain or gross receipts, (depending upon the state) to be
excluded in most states that it will file in under specific state apportionment rules
and/or regulations. For example, in Illinois, Company A will be reporting the Gain as
apportionable business income subject to tax, but will exclude the gross receipts
from the sales apportionment factor under Illinois Section 100.3380(c)(2) which
excludes gross receipts that arise from an occasional sale in the regular course of
business.
Discussion
1. Is the Gain Company A realized considered business income?
The tax treatment of corporate income is determined, in part, by whether the
income is business income or nonbusiness income. Colorado law defines both
“business income” and “nonbusiness income” for corporate income tax purposes.1
1 §§ 39-22-303.5(1)(a) & (c), C.R.S
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These definitions contain a clear presumption, in absence of compelling evidence
to the contrary, that a corporation’s income is business income (“the income of the
taxpayer is business income unless clearly classifiable as nonbusiness income”).2
Furthermore, business income is defined as income derived through the “regular
course of a taxpayer’s trade or business”3 and will, in general, include “all
transactions and activities of the taxpayer that are dependent upon or contribute
to the operation of the taxpayer's economic enterprise as a whole.”4 More specific
to the facts of this case, Colorado regulation states:
“Gain or loss from the sale...of...intangible personal property
constitutes business income if the property while owned by
the taxpayer was used in the taxpayer's trade or business.”5
Company A’s ownership interest in LLC I is intangible personal property.
Company A manufactures and sells products in the aerospace industry. Company
A formed LLC I in furtherance of this purpose and contributed to LLC I contracts
created in the regular course of Company A’s business. Therefore, the Gain
Company A realized from the sale is business income.
Additionally, under Colorado law a corporation may elect to treat all of its income
as business income.6 Consequently, even if the Gain was not properly classifiable
as business income, Company A may elect to treat the Gain as such, along with
the rest of its income.
2. Should Company A include in its apportionment factor its distributive share of
the limited liability company’s gross sales?7
For corporations, Colorado statute prescribes the apportionment of business
income in the ratio of the taxpayer’s total sales in Colorado to the taxpayer’s total
sales everywhere.8 Gross sales that flow up from LLC I to Company A, as a
partner, are treated for federal tax purposes as if the gross sales from such work
was paid directly to Company A9. This approach is consistent with the tax
treatment of a partner’s gross income for federal purposes.10 Thus, where
Company A’s pass-through income from LLC I is business income for Colorado
tax purposes, Company A’s distributive share of LLC I’s gross sales are Company
2 § 39-22-303.5(1)(a), C.R.S.
3 Ibid.
4 Dept. Reg. 1 CCR 201-2, 39-22-303.5.1(A)(2)
5 Dept. Reg. 1 CCR 201-2, 39-22-303.5.1(A)(3)(b)(i)
6 § 39-22-303.5(6), C.R.S.
7 This section of this ruling concerns not the Gain Company A realized, but the pass-through
income it received through its ownership, directly and indirectly, in LLC I.
8 § 39-22-303.5(4), C.R.S.
9 A “partner is generally deemed to be conducting the partnership business directly.”Hellerstein &
Hellerstein, State Taxation, ¶ 9.12[1]. See also Hellerstein & Hellerstein, State Taxation, ¶
20.08[2][b].
10 26 USC § 702. “In any case where it is necessary to determine the gross income for a
partner...such amount shall include his distributive share of the gross income of the partnership.”
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A’s own gross sales. To the extent that the pass-through income that Company A
receives through LLC I is business income, Company A should include its
distributive share of LLC I’s gross sales in its Colorado apportionment factor.
3. Should the Gain be excluded from its Colorado apportionment factor?
Statute and regulation prescribe apportionment on the basis of total gross
receipts11 and the sourcing of gains from sales of intangible property to the
taxpayer’s commercial domicile.12 However, the statute allows for an alternative
apportionment if:
“The apportionment and allocation provisions of this section
do not fairly represent the extent of the taxpayer's activities
in Colorado, the taxpayer may petition for, or the executive
director may require, with respect to all or any part of the
taxpayer's
business
activities,
if
reasonable…[t]he
employment of any other method to effectuate an equitable
apportionment or allocation of the taxpayer's income, fairly
calculated to determine the net income derived from or
attributable to sources in Colorado.”13
Regulation further allows departure from prescribed apportionment methodology
“only in limited and specific cases” that are “unique and nonrecurring” and for
which application of the normal apportionment rules would “produce incongruous
results.”14 In order to achieve more equitable and appropriate apportionment, “[i]n
some cases certain gross receipts should be disregarded in determining the sales
factor in order that the apportionment formula will operate fairly to apportion to this
state the income of the taxpayer's trade or business.”15
Under the standard apportionment rules, “gain from the sale of intangible
property” is assigned to Colorado and included in the numerator of the
apportionment ratio “if the taxpayer’s commercial domicile is in Colorado.”16 As
discussed above, for the purpose of this letter, we assume that Company A is
commercially domiciled in Colorado.
Under the facts presented, sourcing the entire Gain to Colorado on the basis of
commercial domicile would not fairly represent the extent of the taxpayer’s
activities in Colorado. All the accounting, financial, payroll, engineering,
manufacturing, and distribution departments that account for and manage
Company A’s business activities that relate to the Gain are performed in Illinois.
Based on these facts, sourcing the entire Gain to Colorado on the basis of
11 §§ 39-22-303.5(4) and (1)(d), C.R.S.and Dept. Reg. 1 CCR 201-2, 39-22-303.5.4(A)
12 § 39-22-303.5(4)(c)(V), C.R.S. and Dept. Reg. 1 CCR 201-2, 39-22-303.5.4(C)(5)
13 § 39-22-303.5(7)(b)(III), C.R.S.
14 Dept. Reg. 1 CCR 201-2, 39-22-303.5.7(B)(a)
15 Dept. Reg. 1 CCR 201-2, 39-22-303.5.4(A)(2)
16 § 39-22-303.5(4)(c)(V), C.R.S.
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commercial domicile would not effectuate an equitable apportionment or allocation
of the taxpayer's income. Instead, apportionment of the Gain on the basis of the
taxpayer’s other sales, which presumably represent more accurately the
taxpayer’s business activities in the state, appears to most fairly represent the
extent of the taxpayer’s business activities in Colorado.
As a result of these considerations we find that sourcing the Gain based upon
commercial domicile would produce incongruous results and not fairly represent
the taxpayer’s activity in Colorado. In order to effectuate equitable apportionment,
we find it necessary to disregard the Gain in determining the sales factor for
Company A. Consequently, the Gain should be excluded from Company A’s
apportionment factor.
Miscellaneous
This ruling is premised on the assumption that Company has completely and
accurately disclosed all material facts and that those material facts will not change
or be amended. The Department reserves the right, among others, to
independently evaluate Company’s representations. The ruling is null and void if
any such representation is incorrect and has a material bearing on the
conclusions reached in this ruling and is subject to modification or revocation in
accordance to Department Regulation 24-35-103.5.
This ruling is binding on the Department to the extent set forth in Department
Regulation 24-35-103.5. It cannot be relied upon by any taxpayer other than the
taxpayer to whom the ruling is made.
Enclosed is a redacted version of this ruling. Pursuant to statute and regulation,
this redacted version of the ruling will be made public within 60 days of the date of
this letter. Please let me know in writing within that 60 day period whether you
have any suggestions or concerns about this redacted version of the ruling.
Sincerely,
Office of Tax Policy
Colorado Department of Revenue
This ruling cannot be relied upon by any other taxpayer other than the
taxpayer to whom the ruling is made.
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