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The transfer of Massachusetts employees from an in-state company to its out-of-state parent was disregarded for tax purposes by the Massachusetts Appellate Tax Board ("the Board"). The transfer, which established Massachusetts nexus for the parent and caused the parent to be included in the 'nexus combined' corporate excise tax return, allowed the parent's losses to offset the income of other members of the group. The Board decided that the transfers had no valid business purpose other than tax avoidance and violated the sham transaction principle. This decision represented an expansion of the sham transaction doctrine to nexus determinations under Massachusetts law and could signal a new era of scrutiny of business transactions. [Allied Domecq Spirits and Wines USA, Inc. v. Commissioner of Revenue, 2013 Mass. Tax LEXIS 23 (Mass. Tax 2013)].
For the years at issue, Subsidiary was the principal reporting corporation for a nexus combined group of affiliated corporations filing a Massachusetts Corporate Excise Return. Parent, the sole shareholder of Subsidiary had no physical presence in Massachusetts and therefore was not a member of the nexus combined reporting group. In 1996, Subsidiary transferred employees from three of its business departments - insurance, taxation, and internal audit - to Parent, which created a physical presence in Massachusetts for Parent and led to the inclusion of Parent in the Massachusetts combined return. The inclusion of Parent (and its losses) significantly reduced the group's tax liability for the return during the tax years at issue.
The Board found that several internal memoranda and communications from Subsidiary's tax department indicated that the employee transfer was motivated by tax avoidance. Subsidiary argued that the employee transfers advanced the company's efforts to centralize operations, including tax and insurance work. However, the Board found that the company's tax and insurance functions were already centralized, in a different entity, before the tax years at issue.
Parent leased space in Subsidiary's headquarters to house the transferred employees. However, the lease was for a single office, and did not delineate space for three of the transferred employees. Additionally, the rent was not paid in certain years and decreased each year.
Employee Transfers Constituted a Sham
The Board reviewed several court and Board decisions that applied the sham transaction doctrine. The Board recognized that the sham transaction doctrine gives the commissioner the authority to "disregard, for taxing purposes, transactions that have no economic substance or business purpose other than tax avoidance" The question is primarily a factual one and requires close attention to the facts in each case. From these decisions, the Board observed several examples of transactions without a non-tax business purpose, including: a taxpayer entering into a transaction with the guarantee of 'saving state taxes;' a taxpayer's internal memorandum providing that business purposes were 'proposed purely as part of a tax-saving plan;' a taxpayer's tax department being responsible for the development, implementation, and oversight of the business transaction; and a taxpayer's failure to produce evidence supporting the accomplishment of purported business purposes. Ultimately, the Board found that the motivation for establishing nexus in Massachusetts for Parent was 'exclusively to avoid taxes.'
The Board did not categorically reject that centralizing operations or leasing property could support a valid business purpose. Furthermore, the failure of the companies to follow the details of the lease and employee transfer showed that the transaction was strictly motivated for tax avoidance. The Allied USA decision appears to be the first published Massachusetts decision that would permit applying the sham transaction doctrine to questions of nexus. Massachusetts taxpayers should be aware that expansion of the sham transaction doctrine to nexus determinations could subject a new area of business transactions to state scrutiny.
RELATED LINKS: For additional information about sham transactions, see:
1-7 Bender's State Taxation: Principles and Practice § 7.05[b][ii]
1-14 Bender's State Taxation: Principles and Practice § 14.05
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