If a Utah parent company spins off a wholly-owned subsidiary to hold an office building (leasing space back to affiliates) or to centralize intercompany financing (borrowing, lending, and investing for the group), is the new subsidiary automatically part of the parent's unitary combined-report group from inception, are the intercompany rent/interest and dividends eliminated from combined income and the sales/property factors, and is income from unrelated third parties business income?

Plain-English summary

This ruling actually bundles two related but separate requests from the same Utah-parented petrochemicals/packaging group, both asking essentially the same three questions about a new wholly-owned subsidiary.

Request 1 — office-building subsidiary. The parent group's office building (recently constructed in Salt Lake City and occupied by multiple group companies) was going to be transferred, via a tax-free IRC § 351-style transfer, into a brand-new subsidiary formed solely to hold and manage that building. The new subsidiary would then lease space back to the other group companies at arm's-length rates, isolating the building's liability risk and centralizing its management and administration. The Commission agreed the new subsidiary would be part of the unitary group from inception (it's wholly owned, shares the parent's executives/accounting/legal/insurance systems, and the group depends on the space to operate), that intercompany rent and dividends would be eliminated from combined income and the sales factor, and that income from leasing excess space to outside third parties would be business income.

Request 2 — centralized financing subsidiary. Rather than each group company independently negotiating its own borrowing and managing its own excess cash, the parent proposed forming one or more new subsidiaries to centralize all group financing — borrowing externally, then lending internally to group companies at market rates, and investing any temporarily excess funds. Reasons given: lower blended borrowing costs, more efficient cash management, and reduced administrative overhead. The Commission again agreed the new financing subsidiary would be unitary from inception under the same reasoning, that intercompany interest, dividends, sales, and rents would be eliminated from combined income and the sales/property factors, and that interest income the subsidiary earns from lending to the group itself is business income.

The one place the Commission drew a distinction: for the financing subsidiary's investment income (as opposed to its loan-to-affiliates interest income), the Commission declined to give a blanket "yes it's all business income" answer. If the investments are short-term parking of working capital or otherwise serve an operational function, they're business income. But if the financing subsidiary makes investments that aren't sufficiently connected to the group's regular trade or business under governing U.S. Supreme Court apportionment guidelines, that income could be nonbusiness income outside the apportionment formula — a fact-specific question the Commission invited the taxpayer to work through with the Auditing Division as situations arose, rather than pre-clearing categorically.

What this means for you

Corporate groups spinning off an asset-holding or treasury/financing subsidiary

This ruling is a clean template for the standard "isolate an asset or centralize a function in a new wholly-owned subsidiary" restructuring — whether the asset is real estate or a treasury function, expect the new entity to be swept into the unitary combined report from day one if it's wholly owned and functionally tied to the group (shared management/services, and the group needs what the subsidiary provides). Don't expect the restructuring alone to pull income out of Utah's combined-reporting net.

Treasury/finance teams setting up a captive financing entity

If your financing subsidiary does more than lend to affiliates — e.g., it also invests surplus cash in third-party instruments — this ruling flags that the investment income (as distinct from intercompany lending income) needs a separate, fact-specific business-income analysis. Short-term working-capital investments or investments serving an operational purpose are safer; more removed, portfolio-style investments could risk nonbusiness-income treatment (which cuts both ways — it escapes Utah apportionment, but it also means that income isn't automatically folded into the unitary combined income the way loan interest is).

Accountants preparing combined/unitary returns with an affiliated real-estate-holding or financing subsidiary

Confirm you're eliminating intercompany rent AND interest from both combined net income and the sales factor (and rent, specifically, from the property factor too, per § 59-7-404.5) — the ruling repeats the same three-part elimination mechanic (income, sales factor, and where applicable property factor) for both the office-building and financing scenarios.

Common questions

Q: We're forming a new subsidiary just to hold real estate and lease it back to our other companies — does that pull it out of our Utah unitary group?
A: No, according to this ruling — a wholly-owned real-estate-holding subsidiary that's centrally managed and whose space the group depends on to operate is unitary from inception, just like any other group member.

Q: If we centralize borrowing and lending in one financing subsidiary, is all of its income treated the same way for Utah apportionment?
A: Mostly, but not entirely. Interest income from lending to the group's own affiliates is business income under this ruling. But investment income from parking excess cash needs a closer look — short-term/working-capital or operational investments are business income, while more removed investment activity could be nonbusiness income depending on the specific facts.

Q: Do we need to eliminate intercompany rent from both income and the apportionment factors, or just from income?
A: Both, per this ruling — intercompany rent and interest are eliminated from combined net income, and intercompany gross receipts/rents are also excluded from the sales factor and (per § 59-7-404.5) the property factor, to avoid overstating the group's apportioned Utah income.

Citations and references

Statutes (Utah Code Annotated, 1953, as in effect at the time of this 1996 ruling):

• § 59-7-101(27) — defines a "unitary business"/"unitary group" as corporations related through common ownership that are economically interdependent (centralized management, functional integration, economies of scale)
• § 59-7-101(6) — defines "common ownership" as direct/indirect control of more than 50% of voting stock (parent-subsidiary or brother-sister controlled group, IRC § 1563 with 50% substituted for 80%)
• § 59-7-402(1) — requires a unitary group with a Utah-doing-business member to file a combined report of combined net income
• § 59-7-302(1) — defines "business income" as income from transactions in the regular course of the taxpayer's trade or business, including from property whose acquisition/management/disposition is integral to that business
• § 59-7-404 — governs intercompany adjustments in the combined report, including elimination of intercompany income/expenses and dividends from subsidiaries already included in the combined report
• § 59-7-404.5 — requires elimination of intercompany sales for the sales factor and intercompany rents for the property factor

Rules:

• Utah Administrative Rule R865-6-4F — governs consolidated-return intercompany eliminations (applied here by analogy to unitary combined reports); Section J bars gain/loss recognition on intercompany transactions, Section J.3 requires supporting elimination schedules
• Utah Administrative Rule R865-6-8F(A) — presumes income is business income unless clearly classifiable as nonbusiness income, with nonbusiness income narrowly construed

Source

• Landing page: https://tax.utah.gov/commission/rulings/
• Original PDF: https://files.tax.utah.gov/tax/commission/ruling/96-032.htm

Original ruling text

96-032

Response
February 13 1996

Request

Dear Mr. Oveson:

Request for Ruling Regarding Inclusion of XXXXX

XXXXX (XXXXX) respectfully requests a ruling from the Utah State Tax Commission regarding their treatment for tax purposes of the following transaction:

1. XXXXX (XXXXX) is a subsidiary of XXXXX. XXXXX has created a separate subsidiary, XXXXX (XXXXX). Certain assets (office building, etc.) will be transferred to XXXXX from XXXXX. XXXXX owns all of the stock of XXXXX.

2. XXXXX will own the XXXXX office building in Salt Lake City and pay all maintenance and operating costs of the facility. XXXXX will lease space in the building to other members of the XXXXX group as needed.

3. XXXXX is and will continue to be considered a member of the XXXXX unitary group from its inception.

4. For Utah state income tax reporting purposes the following will apply:

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 intercompany transactions.

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

5. Any income derived by XXXXX from the leasing of property or the providing of services 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 produce styrene monomer, polystyrene, as well as a number of other products in the petrochemicals industry and packaging industry.

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

XXXXX

One of XXXXX's subsidiaries, XXXXX, owns an office building in Salt Lake City. The office building was newly constructed and completed during XXXXX. Each of the XXXXX group of companies occupy space in the office building.

For a variety of business reasons XXXXX management deems it prudent to hold the office building in a separate corporation. These business reasons include:

1) reduction of liability risk created by the facility to all other operating, management, finance, and other companies affiliated with XXXXX through isolation of that risk in one corporation;

2) more effective management and utilization of the office building; and

3) reduction of office administration costs.

To facilitate the above, XXXXX management plans to transfer the office building from XXXXX to XXXXX via an IRC Section 351 transfer. Space in the building will be leased to other members of the XXXXX group. Lease payments will be based upon the square footage of space occupied by each separate company and/or other services provided by XXXXX. The rates charged to lease space and/or provide services will be based upon those obtainable from an unrelated party. A separate subsidiary is needed to separate the management of the facility from the many other management matters handled by XXXXX and to isolate the liability which such a facility carries with it.

Analysis of Law and Discussion of Authorities

Issue 1

Utah Code Annotated, 1953 (UCA) Section 59-7-101 (27) defines a unitary business or unitary group as "a group of corporations that: (a) are related through common ownership; and (b) are economically interdependent with one another as demonstrated by the following factors:

(I) centralized management;

(ii) functional integration;

(iii) economies of scale.

UCA Section 59-7-101 (6) defines common ownership as "the direct or indirect control or ownership of more than 50% of the outstanding voting stock of:

(I) a parent-subsidiary controlled group as defined in Section 1563, Internal Revenue Code except that 50% shall be substituted for 80%;

(ii) a brother-sister controlled group as defined in Section 1563, Internal Revenue Code except that 50% shall be substituted for 80%; or

(iii) three or more corporations each of which is a member if a group of corporations described in Subsection (2)(a)(I) or (2)(a)(ii), and one of which is:

(A) a common parent corporation included in a group of corporations described in Subsection (2)(a)(I); and

(B) included in a group of corporations described in Subsection (2)(A)(ii).

From a practical, economic, and business standpoint, the proposed transaction does nothing more than shift the corporate ownership of an office building from one member of the unitary group, XXXXX, to another, XXXXX. The XXXXX unitary business will not otherwise change, notwithstanding the fact that XXXXX will charge the various XXXXX companies rent on their respective office space.

Inasmuch as XXXXX is 100% owned by XXXXX, it will meet the common ownership test. XXXXX's assets will consist of the office building. XXXXX's income will consist mainly of lease income derived from XXXXX unitary companies. Such activity will be unitary with the activities of the XXXXX unitary group members since the space leased will be used by the unitary group in the production of business income, and without access to such office space the unitary group would not be able to efficiently management the production of their various products. Accordingly, the XXXXX companies will clearly be dependent upon XXXXX for such office space.

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

Issue 2

a) UCA Section 59-7-402 (1) provides that any unitary group that has a member(s) which does business in the state of Utah shall file a combined report showing the combined net income of the group. 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., rent 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 3

UCA Section 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- 6-8F(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.

Any assets held by XXXXX are a direct result of or in support of the business of the XXXXX group. Consequently, it would follow that any income generated by these assets would be considered business income under the above definition. The building was acquired and is being utilized by the XXXXX companies as integral parts of the XXXXX unitary business and will continue to be such as a part of XXXXX. While the form in which the XXXXX group owns the office building will change, the substance or manner in which the building is employed by the XXXXX group will remain unchanged.

Accordingly, it follows that the business character of any income derived by any of the XXXXX operating companies from leasing of excess building space to unrelated third parties will transfer to XXXXX when and if XXXXX generates such income from outside parties.

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

Sincerely,

XXXXX

XXXXX

RE: Advisory Opinion - Taxation of new subsidiary

Dear XXXXX,

We have received your request for an advisory opinion regarding taxation of a new, wholly owned subsidiary, "XXXXX." The subsidiary is being formed to manage financing for other members of the XXXXX group. We find as follows:

1. Based on the facts presented, XXXXX is a part of the XXXXX unitary group under criteria set out in sections 59-7-101 (7) and (28) of the Utah Code.

2. Under section 59-7-404 of the Utah Code, a unitary group should make certain intercompany adjustments. It is appropriate to eliminate intercompany income and expenses. However, since these items generally offset on another on a dollar for dollar basis, there is usually no net difference in bottom line income. Further, as suggested in your letter, the company should also eliminate the dividends received from subsidiaries whose income and factors are included in the combined report, since the alternative would result in double inclusion of the dividend paying subsidiary's income in the appropriate tax base. Finally, section 59-7-404.5 of the Utah Code requires elimination of intercompany sales for purposes of determining the sales factor and elimination of intercompany rents for purposes of determining the property factor.

3. We agree that income derived from rents as described in your letter constitute business income.

Please let us know if we can be of further assistance.

For the Commission.

Alice Shearer

Commissioner

XXXXX

Mr. Val Oveson Chairman

Utah State Tax Commission

210 North 1950 West

Salt Lake City, Utah 84134

Dear Mr. Oveson:

Request for Ruling Regarding Inclusion of XXXXX

XXXXX (XXXXX) respectfully requests a ruling from the Utah state Tax Commission regarding their treatment for tax purposes of the following transaction:

1. XXXXX will create one or more separate subsidiaries (XXXXX) to provide and manage financing for members of the XXXXX group. XXXXX or its operating subsidiaries will own all of the voting stock of XXXXX.

2. Financing services provided by XXXXX will include the borrowing and investing of funds for and lending of funds to members of the XXXXX group as needed.

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

4. For Utah state income tax reporting purposes the following will apply:

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 intercompany transactions.

c) Dividends paid by XXXXX to XXXXX or its operating subs will be eliminated as intercompany dividends.

5. Any income derived by XXXXX from the investment or lending of its 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 produce styrene monomer, polystyrene as well as a number of other products in the petrochemicals industry and the packaging industry.

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

XXXXX

Currently the XXXXX group of companies borrow money on a separate company basis. Each separate company negotiates their own credit terms, credit line amounts, etc. resulting in a number of different borrowing rates and conditions. Each company also independently invests any excess funds temporarily on hand.

For a variety of business reasons XXXXX management deems it prudent to centralize the financing process. These business reasons include:

1) reduction of borrowing costs through consolidation of all loans and debt obligations into one or more large centralized loans with a much lower effective interest rate;

2) creation of more effective management of funds investment through combination of all investment activities into one entity;

3) reduction of administration costs through administering fewer loans;

4) creation of more efficient and effective cash flow through consolidation of money management;

To facilitate the above, XXXXX management plans to form one or more new subsidiaries (XXXXXs) to borrow, loan and invest money. Initial financing will be acquired by XXXXX and then loaned to XXXXX. A separate subsidiary is needed to separate the management of finances from the many other management matters handled by XXXXX. More than one XXXXX may be required due to minority ownership of certain XXXXX operating subsidiaries. XXXXX will then loan money to the various other subsidiaries of XXXXX and charge interest at a rate comparable with that at which the companies could obtain financing in the open market.

Analysis of Law and Discussion of Authorities

Issue 1

Utah Code Annotated, 1953 (UCA) Section 59-7-101 (27) defines a unitary business or unitary group as "a group of corporations that: (a) are related through common ownership; and (b) are economically interdependent with one another as demonstrated by the following factors:

(I) centralized management;

(ii) functional integration;

(iii) economies of scale.

UCA Section 59-7-101 (6) defines common ownership as "the direct or indirect control or ownership of more than 50% of the outstanding voting stock of:

(I) a parent-subsidiary controlled group as defined in Section 1563, Internal Revenue Code except that 50% shall be substituted for 80%; or

(ii) a brother-sister controlled group as defined in Section 1563, Internal Revenue Code except that 50% shall be substituted for 80%; or

(iii) three or more corporations each of which is a member if a group of corporations described in Subsection (2)(a)(I) or (2)(a)(ii), and one of which is:

(A) a common parent corporation included in a group of corporations described in Subsection (2)(a)(I); and

(B) included in a group of corporations described in Subsection (2)(A)(ii).

From a practical, economic, and business standpoint, the creation of XXXXX does nothing more than shift the corporate obligation of debt from various members of the unitary group to one member of the group, XXXXX. The XXXXX unitary business will not otherwise change, notwithstanding the fact that XXXXX will charge the various XXXXX companies interest on their respective borrowings.

In that XXXXX will be nearly 100% owned by XXXXX, it will meet the common ownership test. XXXXX's assets will consist of the notes receivable from the other members of the group and potentially some other investments. XXXXX's income will consist mainly of interest income derived from XXXXX unitary companies. Such activity will be unitary with the activities of the XXXXX unitary group members since the money loaned will be used by the unitary group in the production of business income, and without access to such financing the unitary group would not be able to produce their various products. Accordingly, the XXXXX companies will clearly be dependent upon XXXXX for such financing.

Additionally, XXXXX will be managed by XXXXX executives, and utilize various XXXXX resources such as common accounting systems, legal services, insurance services, etc. 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 2

a) UCA Section 59-7-402 (1) provides that any unitary group that has a member(s) which does business in the state of Utah shall file a combined report showing the combined net income of the group. 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., interest 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 3

UCA Section 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- 6-8F(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.

Any assets held by XXXXX including the loans to other subsidiaries and instruments used to invest excess funds are a direct result of or in support of the business of the XXXXX group. Consequently, it would follow that any income generated by these assets would be considered business income under the above definition. The loans were acquired and utilized by the XXXXX companies as integral parts of the XXXXX unitary business and will continue to be such as a part of XXXXX. While the form in which the XXXXX group obtains and manages financing will change, the substance or manner in which the financing is employed by the XXXXX group will remain unchanged.

Accordingly, it follows that the business character of any income derived by any of the XXXXX operating companies from investment of excess funds in unrelated third party instruments will transfer to XXXXX when and if XXXXX generates such income from outside parties.

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

Sincerely,

XXXXX

XXXXX

RE: Advisory Opinion - Taxation of new subsidiary

Dear XXXXX,

We have received your request for an advisory opinion regarding taxation of a new, wholly owned subsidiary, "XXXXX." The subsidiary is being formed to manage financing for other members of the XXXXX. We find as follows:

1. Based on the facts presented, XXXXX is a part of the XXXXX unitary group under criteria set out in sections 59-7-101(7) and (28) of the Utah Code.

2. Under section 59-7-404 of the Utah Code, a unitary group should make certain intercompany adjustments. It is appropriate to eliminate intercompany income and expenses. However, since these items generally offset on another on a dollar for dollar basis, there is usually no net difference in bottom line income. Further, as suggested in your letter, the company should also eliminate the dividends received from subsidiaries whose income and factors are included in the combined report, since the alternative would result in double inclusion of the dividend paying subsidiary' s income in the appropriate tax base. Finally, section 59-7-404.5 of the Utah Code requires elimination of intercompany sales for purposes of determining the sales factor and elimination of intercompany rents for purposes of determining the property factor.

3. With regard to the issue of whether XXXXX's income is business income for purposes of determining income apportionment, income received from members of the unitary group from intercompany loans constitute business income. However, with regard to the investment income, we decline to agree to the broad statement in your letter. If the investments constitute short term investments of working capital or investments that service operational function, the income qualifies as business income. However, XXXXX may have investment income that arises from transactions that are not sufficiently related to the business for apportionment under U.S. Supreme Court guidelines. Therefore. whether income arising from XXXXX's various investment transactions is business income depends on the circumstances surrounding the investment in question. We invite you to work with our Auditing Division to resolve those questions as they arise.

Please let us know if we can be of further assistance.

For the Commission,

Alice Shearer

Commissioner