SC Supreme Court Says No to Excluded Dividends-Related Expenses Deduction

An out-of-state corporation that filed a South Carolina corporate income tax return excluded dividends generated from South Carolina income of certain wholly owned subsidiaries. However, the South Carolina Supreme Court ultimately decided that the taxpayer was not entitled to exclude expenses associated with the production of such income. See Emerson Elec. Co. v. S.C. Dep't of Revenue, 2011 S.C. LEXIS 390 (S.C. Dec. 12, 2011).

Emerson Electric is a corporation with its principal place of business in Missouri and operations worldwide, including in South Carolina. The taxpayer filed a consolidated South Carolina corporate income tax return for the years 1999-2001. While the original returns did not deduct expenses attributable to the intercompany dividends generated from South Carolina income, it later filed amended returns which deducted such expenses and sought refunds. The South Carolina Department of Revenue denied the claim for refunds, and such denial was upheld by the administrative law judge.

The South Carolina Supreme Court found that the intercompany dividends were properly excluded from income by the taxpayer based on the state's conformity to the Internal Revenue Code. The parties stipulated that the expenses at issue were attributable to the excluded dividends. However, a matching principle requires that expenses associated with producing income that is not subject to tax may not be deducted. The Court held that this matching principle was controlling, and prohibited the taxpayer from deducting the expenses.

The taxpayer was allowed to challenge prior precedent and argued that S.C. Code Ann. § 12-6-2220 authorized the deduction, where it provides that:

The following items of income must be directly allocated and excluded from the apportioned income and the apportionment factors:

...(2) Dividends received from corporate stocks not connected with the taxpayer's business, less all related expenses, are allocated to the state of the corporation's principal place of business as defined in S.C. Code Ann. § 12-6-30 or the domicile of an individual taxpayer. (emphasis added)

The taxpayer argued that the denial of a deduction for the expenses, combined with a deduction of such expenses in its home state of Missouri, was tantamount to a violation of its constitutional rights.

The Court rejected the taxpayer's argument and upheld the denial of the deduction. The Court explained that the mere fact that a particular aspect of Missouri corporate income tax law denied the taxpayer a deduction for these expenses did not amount to a constitutional infirmity of S.C. Code Ann. § 12-6-2220 and upheld the denial of the expenses.

While the taxpayer's argument in this case seemed persuasive, the decision of the Court seems to be a reasonable and logical outcome. Taxpayers considering this issue, or other similar ones, should re-evaluate the merits of their claim in light of this recent decision.

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RELATED LINKS: For additional inisight into dividends received deduction matters, see:

• Bender's State Taxation: Principles and Practice § 3.06 - State Adjustments to Federal Taxable Income

• Bender's State Taxation: Principles and Practice § 7.08 - States' Adjustments to Federal Taxable Income Base 

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