If a Utah parent company contributes its trade name, logo, and proprietary technology to a newly formed IP-holding subsidiary in exchange for stock, is the contribution tax-free, is the new subsidiary automatically part of the parent's unitary group from day one, and is the royalty income the subsidiary earns from licensing that IP back to affiliates (and to outsiders) treated as apportionable business income?

Plain-English summary

In 1990, the Utah parent corporation of the largest North American producer in its industry (with affiliated companies making related products) asked the Utah State Tax Commission to bless a planned corporate restructuring. The parent planned to form a new, wholly-owned Utah subsidiary and contribute to it its trade name, logo, and proprietary manufacturing technology (patents, trade secrets, know-how, licenses) solely in exchange for the subsidiary's stock. The new subsidiary would then license that intellectual property back to the parent's own operating companies — and to unrelated third parties — for an arm's-length royalty. The parent gave several legitimate business reasons for doing this: centralizing IP protection and enforcement, insulating the IP from operating-company liabilities and infringement suits, enabling cleaner acquisitions of new IP without disclosing end users, better measuring each operating unit's financial performance, and preserving control over IP even if an operating unit were later sold.

The Commission's Auditing Division, through Chairman R.H. Hansen, agreed with the taxpayer's own proposed answers on all four issues raised. Issue 1 (tax-free contribution): Utah doesn't literally incorporate IRC § 351, but Utah's franchise/income tax computation starts from federal taxable income, and Utah Code Ann. § 59-7-115(2)(e) contains parallel nonrecognition language for a controlled-corporation stock-for-property exchange — so no Utah gain or loss is recognized on the contribution. Issue 2 (unitary group status): the new IP-holding subsidiary meets Utah's unitary-business test (§ 59-7-302(15)) from its very inception — it's 100%-owned (satisfying the common-ownership test at § 59-7-302(3)), shares the same general line of business through the licensed technology, and is functionally integrated via shared parent-company executives, accounting, legal, insurance, and financing — even though its only "product" is licensing IP for royalties. Issue 3 (intercompany eliminations): consistent with the combined-report rules in Utah Admin. Rule R865-6-4F (written for consolidated returns but applied by analogy to unitary combined reports), intercompany royalties paid by the operating companies to the new subsidiary are eliminated both from the combined income computation and from the sales-factor numerator/denominator, and intercompany dividends paid up to the parent are similarly excluded, all to avoid double-counting the same economic activity. Issue 4 (business income classification): even though the IP moves to a separate holding entity, it stays business income — not investment-type nonbusiness income — because the IP remains actively managed by the same personnel and remains an integral, ongoing part of the group's regular trade or business (without it, the group couldn't make its core products); this holds true for royalties from unrelated third-party licensees too, not just from affiliates.

What this means for you

Corporate groups considering an IP-holding-company restructuring

This ruling is a useful, if dated, illustration of how Utah analyzed a common corporate structure: centralizing trademarks/technology in a separate subsidiary for liability-insulation and IP-management reasons doesn't, by itself, escape Utah's unitary combined-reporting regime — if the new entity is wholly owned and functionally tied to the group (shared management, shared services, and the licensed IP is what makes the group's core products possible), expect it to be swept into the unitary group from day one, with intercompany royalties eliminated from combined income and the sales factor.

Tax and corporate counsel structuring similar restructurings today

While the specific mechanics here (Utah's approach to IRC § 351-style nonrecognition, the unitary-business factors, and business-income classification) remain conceptually useful, this is a 1990s-era ruling — Utah's corporate tax statutes, combined-reporting regulations, and the case law on unitary business and business/nonbusiness income (including later U.S. Supreme Court and Utah decisions) have developed considerably since. Treat this as a historical data point on the Commission's reasoning, not a citable current authority, and re-verify against current statute numbering and case law.

Accountants preparing combined/unitary returns for affiliated groups with an IP subsidiary

The ruling's Issue 3 analysis is a clear, generalizable statement of the elimination mechanics for combined reports: intercompany royalties are excluded from both the numerator and denominator of the sales factor (not just netted from income), and intercompany dividends are excluded from combined net income — get both eliminations right to avoid overstating (or understating) the group's apportioned Utah income.

Common questions

Q: If we move our trademark and technology into a new subsidiary in exchange for its stock, do we owe Utah tax on that contribution?
A: Not under this ruling's facts — Utah followed its § 59-7-115(2)(e) nonrecognition provision (parallel to federal IRC § 351), so no gain or loss was recognized on the contribution.

Q: Is a newly formed, wholly-owned IP-licensing subsidiary automatically excluded from our unitary combined report just because it doesn't manufacture anything?
A: No — this ruling found the opposite. Because the subsidiary was wholly owned, shared centralized management and services with the group, and its licensed IP was essential to the group's core manufacturing, the Commission treated it as unitary from inception.

Q: How do we handle the royalties our IP subsidiary charges our own operating companies on our combined Utah return?
A: Per this ruling, eliminate them as intercompany transactions — both from combined net income and from the sales factor's numerator and denominator — to avoid double-counting.

Q: Does royalty income from LICENSING TO OUTSIDE, unrelated companies count differently than royalties from our own affiliates?
A: Not for business-income classification purposes — this ruling treated royalty income from both related and unrelated licensees as apportionable Utah business income, since the underlying IP remained an integral, actively managed part of the group's regular trade or business either way.

Citations and references

Statutes (Utah Code Ann., as in effect in 1990):

• § 59-7-115(2)(e) — nonrecognition of gain or loss on a transfer of property to a corporation solely in exchange for stock/securities where the transferor(s) control the corporation immediately after (Utah's parallel to IRC § 351)
• § 59-7-302(1) — defines "business income" as income from transactions in the regular course of the taxpayer's trade or business, including from tangible/intangible property whose acquisition, management, or disposition is an integral part of that business
• § 59-7-302(3) — defines "common ownership" as direct or indirect control/ownership of more than 50% of a corporation's outstanding voting stock
• § 59-7-302(15) — defines "unitary business"/"unitary group" as two or more commonly owned corporations whose activities are integrated with, dependent upon, and contribute to each other (same general line of business, vertical or horizontal integration, economic interdependence via centralized management/functional integration/economies of scale)
• § 59-7-304(1) — requires corporations meeting the unitary-business definition to file a combined report of their combined net income

Rules:

• Utah Admin. Rule R865-6-4F — governs consolidated-return filing requirements, including intercompany-transaction elimination (Section J) and required supporting schedules (Section J.3); applied here by analogy to a unitary combined report
• Utah Admin. Rule R865-6-7F(A) — clarifies that a taxpayer's income is presumed business income unless clearly classifiable as nonbusiness income, with nonbusiness income narrowly construed

Source

• Landing page: https://tax.utah.gov/commission/rulings/
• Original page: https://files.tax.utah.gov/tax/commission/ruling/90-006.htm

Original ruling text

Response August 17, 1990

August 17,
1990

XXXXX

Dear
XXXXX:

Your
letter dated August 2, 1990 requesting a ruling on potential Utah taxation of a
proposed transaction in which certain business assets of XXXXX would be
transferred to a newly formed subsidiary has been referred to the Auditing
Division for their analysis.

The
Auditing Division recommendation is outlined below. This recommendation is based on the facts as represented in the
August 2, 1990 letter. Any deviation from the facts as represented may negate
the response given below. In addition, if you are in disagreement with the
staff recommendation, you have the right to appeal to the Commission by filing
a petition for redetermination within thirty (30) days from the mailing date of
this letter.

Responses
in this letter will correspond to issues one through four as outlined in your
letter.

ISSUE
1

Utah
does not specifically follow IRC 351. However, similar language to IRC 351
appears in U.C.A. 59-7-115(2)(e) which reads:

"No
gain or 1088 shall be recognized if property is transferred to a corporation by
one or more persons or corporations solely in exchange for stock or securities
in such corporation and if immediately after the exchange such persons or
corporations are in control of the corporation."

Utah
would not recognize any gain or 1088 on the IRC 351 transaction because similar
language is found in the Utah statute which exempts this transaction.

ISSUE
2

Based
on the facts presented in your letter, it appears that XXXXX would clearly form
a part of XXXXX's unitary business since the requirements of U.C.A. 59-7-302
(15) regarding unitary businesses would be met. Such factors include the
assertion that the companies are engaged in the same general line of business,
economic interdependence, strong centralized management, functional
integration, the attainment of operational economies of scale and other
factors.

ISSUE
3

In
the case of a Utah combined report, certain intercompany eliminations are
required in order to avoid duplicative taxation or the duplication of expenses.
These items would include elimination of intercompany sales and expenses,
dividends etc. It should be noted that
intercompany sales and expenses ordinarily wash for purposes of the computation
of income. However, all such
duplications relating to the three factor formula of property, payroll and
sales must be eliminated in order to avoid doubling up on the factor numerators
and denominators.

ISSUE
4

Based
on the assertions that those assets being transferred into XXXXX (i.e. the
XXXXX trade name and logo, and certain technologies) were created or acquired
in the ordinary course of business and form an integral part of the business of
XXXXX and Subsidiaries and that these assets will continue to form an integral
part of such business, the income from these assets will be considered as
business income under U.C.A. 59-7-302 (1). It has been Utah's consistent
position over the years that these types of assets would, except in very
unusual or rare circumstances, be considered business assets and thus income
from such assets should be apportioned as business income.

As
a final note, we are in agreement with your proposed treatment of the
transaction in question and the future filing methods to be used following the
consummation of the proposed reorganization. Should you have additional
questions concerning this response or other concerns related to this matter,
please contact the Auditing Division at (801) 530-6358.

Respectfully,

R.
H. Hansen

Chairman

TO: R. H. HANSEN, Chairman

FROM: XXXXX, Director, Auditing Division

DATE: August 17, 1990

RE: Ruling Request from XXXXX

Attached
is a request for a declaratory judgement from XXXXX which is representing
XXXXX.

We
have taken the liberty of drafting a response for your consideration. The
proposed response generally agrees with the conclusions of the taxpayer. If you
agree with our response, please sign and forward the attached letter.

August
2, 1990

XXXXX

Manager,
Corporation Audit

Mail
Stop 02-2

Utah
State Tax Commission

160
East Third South

Salt
Lake City, Utah 84134

Dear
XXXXX,

Request
for Ruling Regarding Inclusion of XXXXX Subsidiary in Unitary Group

On
behalf of our client, XXXXX (XXXXX), we respectfully request the following
ruling from the Utah State Tax Commission:

The
contribution of certain business assets, specifically the XXXXX trade name and
logo, and certain proprietary technologies by XXXXX to a newly formed
subsidiary corporation (XXXXX) will be considered a nontaxable contribution to
capital.

XXXXX
will be considered a member of the XXXXX unitary group from its inception.

a) As a member of the XXXXX unitary group,
XXXXX's income, to the extent derived from unitary XXXXX companies, will be
eliminated as intercompany transactions.

b)
XXXXX's gross receipts from such transactions will be eliminated from the sales
factor as an intercompany transaction.

c) Dividends paid by XXXXX to XXXXX will be
eliminated as intercompany dividends.

Any
income derived by XXXXX from the licensing of its intangible assets to
unrelated third-parties will be classified as business income subject to
apportionment for Utah tax purposes.

Summary
Of the Parties and the Transaction

XXXXX
is the Utah parent corporation of a number of subsidiaries that together
comprise the largest producer of XXXXX in North America. XXXXX and its
affiliated companies also produce XXXXX and XXXXX.

XXXXX's
address, federal identification number and Utah charter number are as follows:

Utah
Charter No. XXXXX

Collectively,
the XXXXX group produces XXXXX, which is used by unrelated third party
manufacturers to make a variety of products ranging from XXXXX to XXXXX, from
XXXXX to XXXXX, from XXXXX to the familiar "XXXXX" XXXXX used by
XXXXX. The XXXXX group also produces XXXXX, which is converted by third parties
into XXXXX, XXXXX for XXXXX and XXXXX for residential, commercial and
industrial construction. The XXXXX group also produces XXXXX, which is a XXXXX
used by XXXXX and unrelated third-parties as the primary raw material in the
manufacturing of XXXXX, XXXXX, and many other XXXXX and XXXXX.

Over
time, XXXXX has created, acquired and/or enhanced various valuable intangible
assets, including the "XXXXX" trade name and the "XXXXX"
logo, and certain proprietary technologies relating to the manufacture of XXXXX
and XXXXX.

The
XXXXX technology includes any and all technical information relating to the manufacture,
sale and use of products produced at XXXXX's XXXXX plants, including, but not
limited to all intellectual property, copyrights, know-how, trade secrets,
assignable licenses, patents and product and process information.

The
XXXXX technology includes any and all technical information relating to the
manufacture, sale and use of XXXXX. Such technology includes all intellectual
property, copyrights, know-how, trade secrets, assignable licenses, patents and
product and process information.

For
a variety of business reasons XXXXX management deems it prudent to centralize
the aforementioned intangibles in a separate entity. These business reasons
include:

1) centralized control leading to reductions in
costs to enforce and protect trademarks, trade names, patents, licenses,
processes and other proprietary intellectual property,

2) insulation of the intangibles from the
liabilities of the XXXXX operating companies;

3) insulation of the assets of the XXXXX operating
companies from any liabilities arising from unforeseen infringement actions
brought by third-parties in connection with the intangibles;

4)
ability to acquire new intangibles without disclosing the name(s) of the
ultimate user(s), leading to lower acquisition costs;

5) better measurement of the financial
operating performance of the XXXXX operating units and their respective
managers; and,

6) ability to sell operating units while
retaining control of intangibles employed by such units. To facilitate the
above, XXXXX management plans to form a new wholly-owned subsidiary (XXXXX) to
hold the XXXXX trade name and logo, and the XXXXX and XXXXX technology (the
XXXXX intangibles"). XXXXX will contribute the XXXXX intangibles to XXXXX
solely in exchange for XXXXX stock. XXXXX will then license the XXXXX
intangibles to the various XXXXX group companies and unrelated third-parties.
XXXXX will charge a periodic arm's-length royalty to each related and unrelated
licensee. XXXXX will be incorporated and commercially domiciled in Utah, where
it will be managed and directed by XXXXX executives.

Analysis
of Law and Discussion of Authorities

Issue
1

Internal
Revenue Code (IRC) § 351(a) provides that "no gain or loss shall be
recognized if property is transferred to a corporation by one or more persons
solely in exchange for stock in such corporation and immediately after the
exchange such person or persons are in control of the corporation". For
federal tax purposes, the contribution of the XXXXX intangibles to XXXXX will
be subject to the provisions of IRC § 351.

Utah
law does not specifically incorporate the Internal Revenue Code by reference.
However, the computation of Utah franchise and income tax as reflected on Form
TC- 20 begins with federal taxable income (before net operating loss and
special deductions), line 28 of federal form 1120, as modified by specific Utah
adjustments.

Inasmuch
as the computation of Utah net income begins with federal taxable income, it
follows that Utah adopts the provisions of IRC § 351, barring any specific Utah
adjustments. None of the Utah modifications require recognition of a
transaction that falls under IRC § 351. Therefore, for Utah income tax
purposes, XXXXX should not recognize any gain or loss on the contribution of
the XXXXX intangibles to XXXXX.

Utah
Code Annotated, 1953 (UCA) § 59-7-302 (15) defines a unitary business or
unitary group as "two or more corporations related through common
ownership whose business activities are integrated with, dependent upon, and contribute
to each other".

UCA
§ 59-7-302 (3) defines common ownership as "in the case of corporations
means the direct or indirect control or ownership of more than 50% of the
outstanding voting stock of the corporation carrying on the unitary business activity.
Unitary business activity can ordinarily be illustrated where the activities of
the corporations are:

(i)
in the same general line of business, such as insurance, transportation, or
finance, or the manufacturing, wholesaling, or retailing of similar products;

(ii)
steps in a vertically integrated enterprise or process; or

(iii)
horizontally integrated;

and
the corporations are economically interdependent as demonstrated by the exercise
of strong centralized management, functional integration, and attainment of
operational economies of scale. Tax haven corporations shall be included in the
unitary group".

From
a practical, economic and business standpoint, the creation of XXXXX does
nothing more than shift the corporate ownership of the XXXXX business
intangibles from one member of the unitary group, XXXXX, to another member of
the unitary group, XXXXX. The XXXXX unitary business will not otherwise change,
notwithstanding the fact that XXXXX will charge the various XXXXX companies a
royalty for their respective use of the XXXXX intangibles. Inasmuch as XXXXX will be 100% owned by
XXXXX, it will meet the common ownership test. XXXXX's assets will consist of
the XXXXX intangibles, which will be contributed to XXXXX by XXXXX. XXXXX's
income will consist of royalty income, the majority of which will be derived
from XXXXX unitary companies for use of the XXXXX intangibles. Such activity
will be unitary with the activities of the XXXXX unitary group members since
the XXXXX intangibles will continue to be used by the unitary group in the
production of business income, and without access to such proprietary
technology, the unitary group would not be able to produce XXXXX and XXXXX, the
very core of the XXXXX unitary business. Accordingly, the XXXXX companies will
clearly be dependent upon XXXXX for such technology.

Additionally,
XXXXX will be managed by XXXXX executives, and utilize various XXXXX resources
such as common accounting systems, legal services, insurance services and
financing. We believe that the above factors clearly establish that XXXXX will
be functionally integrated with the XXXXX companies, and will be considered a
part of the XXXXX unitary group from XXXXX's inception.

Issue
3

a) UCA § 59-7-304 (1) provides
that corporations meeting the definition of a unitary business shall file a
combined report showing the combined net income of all such corporations. Utah
Rule R865-6-4F discusses the requirements for affiliated corporations filing a
consolidated return in Utah. Section J of the rule provides that no gain or
loss is recognized on intercompany transactions, other than provided elsewhere
in the rule. Section J.3 provides that supporting schedules should be filed
with the consolidated return, including a column showing the intercompany
eliminations and adjustments.

Although
Rule R865-6-4F discusses the requirements for filing a Utah consolidated
return, we believe that the same principles regarding the treatment of intercompany
transactions apply in a unitary report context as well.

As
applied to the instant case, we believe the logic of Rule R865-6-4F supports a
finding that business income derived by XXXXX from other members of the XXXXX
group should be eliminated from the computation of unitary business income,
given its intercompany character.

b)
Based on the statutory support shown in a), it follows that any intercompany
gross receipts (i.e., royalties paid from XXXXX companies to XXXXX) should be
excluded from the combined sales factor of the unitary group for Utah purposes.

c)
In addition to the statutory support shown in a), the 1989 instructions for
filing Form TC-20 provide that in the preparation of a combined return, any
intercompany dividends are excluded from the total unitary net income. In
combination, these factors support a finding that any intercompany dividends
paid by XXXXX to XXXXX should be excluded from the computation of the XXXXX
group's unitary business income.

Issue
4

UCA
§ 59-7-302(1) defines "business income" as income arising from
transactions and activity in the regular course of the taxpayer's trade or
business and includes income from tangible and intangible property if the
acquisition, management, and disposition of the property constitutes integral
parts of the taxpayer's regular trade or business operations. Utah Rule
R865-6-7 F(A) further elaborates on this definition by providing that the
income of the taxpayer is business income unless clearly classifiable as
nonbusiness income, and that the definition of nonbusiness income shall be
narrowly construed.

The
intangible assets in question were acquired or developed and are managed by
XXXXX as an integral part of the XXXXX unitary business. Accordingly, these
assets are properly classified as business assets in the hands of XXXXX. Any
income derived from third-parties by XXXXX for the use of such assets is
properly classified as business income for Utah state tax purposes.

Notwithstanding
the fact that the XXXXX intangible assets will be contributed by XXXXX to XXXXX
for the business reasons stated herein, the XXXXX intangible assets will
continue to be managed by XXXXX personnel and will remain a valuable and
integral part of the XXXXX group's regular trade or business. Therefore, while
the form in which the XXXXX intangible assets are held by the XXXXX group will
change, the substance or manner in which the XXXXX intangible assets are
employed by the XXXXX group will remain unchanged.

Accordingly,
it follows that the business character of any income derived by XXXXX from
licensing the XXXXX intangible assets to unrelated third-parties will transfer
to XXXXX when the XXXXX intangible assets are contributed to XXXXX by XXXXX as
detailed herein.

If
you have any questions or if we can provide you with any additional
information, please call XXXXX (XXXXX) or XXXXX (XXXXX). We appreciate your
consideration of this request at your earliest convenience.

Yours
very truly,