The Massachusetts Department of Revenue (DOR) released for public comment a working draft of a "revision and restatement" to Technical Information Release (TIR) 10-16: Non-US Corporation with US Income Exempt from US Tax Pursuant to a Bilateral US Income Tax Treaty (TIR 10-16). (Click here for a redlined copy of the revised version.) The revisions focus on the calculation of the non-income measure of the corporate excise tax and exclusion of receipts, property or payroll related to treaty-exempt income from the corporation's Massachusetts apportionment formula. Comments should be emailed to the DOR's Rulings and Regulations Department at rulesandregs@dor.state.ma.us, by close of business on July 21, 2017.

Background

Massachusetts taxation of non-US corporations

Massachusetts enacted mandatory unitary combined reporting effective for tax years beginning on or after January 1, 2009. Under the default "water's edge" method of reporting under Massachusetts' combined reporting regime, non-US corporations may be included in a "water's edge" combined group in numerous ways, including:

— Having nexus with Massachusetts (regardless of whether it has a federal income tax filing obligation)

— Having on average at least 20% of its apportionment factors in the US

— Deriving 20% or more of its income from intangible property (including intercompany loans) or service-related expenses to US affiliates that are part of a Massachusetts combined group

As TIR 10-16 explains, the Massachusetts corporate excise tax conforms to the definition of gross income under the Internal Revenue Code (IRC). For non-US corporations, this includes:

only (1) gross income that is effectively connected with the conduct of a trade or business within the US ("effectively connected income") ["ECI"] and (2) gross income that is derived from sources within the US and that is not [ECI], which would include among other things items of non-[ECI] on which the US federal income tax may be collected through withholding imposed on the payers of such items. See IRC Section 882(b); see also IRC Section 881(a), 882(a).

As a general matter, however, states are not party to US tax treaties and, therefore, are not bound by them.¹ Thus, to the extent a tax treaty modifies the application of IRC Sections 882 or 881 for a non-US taxpayer, states are not bound to follow this deviation from the usual treatment under the IRC. The Massachusetts tax code historically has been silent on its treatment of US tax treaties. And, as originally enacted, the Massachusetts combined reporting statute (codified at Mass. Gen. Laws, ch. 63, Section 32B) also was silent on whether Massachusetts conformed to the federal treatment of income excluded by a US bilateral income tax treaty.

The DOR's original 2009 combined reporting regulation contained confusing language regarding the computation of gross income for non-US corporations whose income was excluded under the provisions of a tax treaty. This raised concerns among taxpayers and practitioners in the early days of the new combined reporting regime that the DOR would seek to tax the income of non-US corporations whose income was excluded for federal income tax purposes by a tax treaty. In reaction to this concern, in 2010, the Legislature amended the combined reporting statute to clarify that, "an item of income of a corporation that is organized outside of the United States shall not be included in the combined group's taxable income to the extent that such item is exempt from United States federal income tax by virtue of a federal income tax treaty." The statute further provided that any "apportionment factors related to such item of exempt income shall be excluded in the determination of taxable net income or loss."

Thereafter, the DOR released TIR 10-16 to explain its interpretation of this statutory change and the application to the computation of corporate excise tax, including the non-income measure of the tax.

Original TIR 10-16

TIR 10-16 is complex and goes into a granular level of detail to explain the DOR's computation of the corporate excise tax of non-US corporations. The DOR also took some notable positions in TIR 10-16 for which there was no explicit guidance in the corresponding Massachusetts tax statutes.

In TIR 10-16, the DOR explained that, although it was not bound to follow US tax treaties outside the combined reporting context, as Massachusetts tax law was silent on this point in the separate reporting context, it would interpret the new statutory amendment pertaining to US tax treaties as applying equally to non-US corporations filing on a separate-company basis.

More controversially, the DOR took the position that, although the apportionment factors related to income that was excluded from the tax base by virtue of a US tax treaty are excluded for purposes of the income measure of the corporate excise, this exclusion did not apply to the non-income or net worth-based measure of the corporate excise tax. Thus, any apportionment factors that were excluded from the computation of the income-based measure of the tax were added back to compute the net worth-based tax. This is a potentially meaningful distinction for non-US based corporations because the net-worth based tax is computed based on a corporation's worldwide balance sheet.

Contrary guidance in apportionment regulations

Subsequently, in 2015, the DOR amended its apportionment regulation in connection with the legislative change to market-based sourcing starting in 2014. This regulation provided that, according to Massachusetts' apportionment regulations applicable to general corporations, " … where items of gross income are excluded from the federal gross income of a taxpayer, the gross receipts to which such items of gross income are directly attributable are similarly excluded from the numerator and denominator of the taxpayer's sales factor. Also, any property or payroll (or appropriate portion thereof) that relate to such receipts are similarly excluded from the property or payroll factors of the taxpayer."² This regulatory language was directly at odds with the above-stated guidance in TIR 10-16 on the impact of treaty excluded apportionment factors for non-income measure tax purposes, and as such there was some ambiguity as to the DOR's position on this issue.

Proposed revisions to TIR 10-16

The DOR's proposed changes to TIR 10-16 appear to be generally consistent with its stated purpose in amending this guidance, specifically that the proposed TIR 17-XX,

amends sections … with respect to the calculation of the non-income measure of the corporate excise, consistent with 830 CMR 63.38.1 ("Apportionment of Income"), as amended in 2014, which provided that any receipts, property or payroll related to items excluded from a corporation's federal gross income are excluded from the computation of the corporation's apportionment percentage. 830 CMR 63.38.1(9)(e); see 830 CMR 63.32B.2(7)(f).

For example, the revised TIR now clearly states in section IV on the computation for the non-income measure of the excise tax for combined group members that:

[f]ollowing the rules that apply to the calculation of the income measure, a taxable or non-taxable combined group member will exclude in the determination of its apportionment percentage to be applied for non-income measure purposes any of its property, payroll and receipts that are attributable to the treaty-exempt income.

Of note, the DOR continues to take a contrary position for taxpayers that are exempt from the income measure of the excise under P.L. 86-272 rather than by virtue of a US tax treaty. The DOR's position here remains unchanged from the original TIR 10-16.³ The Massachusetts statute imposing the corporate excise tax specifically provides that taxpayers that are exempt from the income measure of the income tax by P.L. 86-272⁴ remain subject to the non-income-based measure of the tax or the $456 minimum tax, whichever is greater. In such a case, the DOR provides in the TIR that, " … the corporation's Massachusetts receipts that are not considered for purposes of the determination of the income measure are nonetheless considered in determining the corporation's non-income measure [in the case of a taxpayer exempt from tax by P.L. 86-272.]"

Implications

Given the complex interaction among: 1) the federal computation of gross income for non-US taxpayers; 2) the impact of numerous and various tax treaties on this computation; and 3) Massachusetts' conformity to the federal income tax treatment of non-US corporations, including apportionment and non-income-based tax considerations, the proposed revisions to TIR 10-16 merit a close reading by US taxpayers and taxpayers with non-US affiliates. Taxpayers interested in providing comments to the DOR should consider whether the proposed changes enhance the clarity of this administrative guidance, whether there are any unanswered questions, and whether the guidance is adverse or beneficial. In addition, taxpayers exempt from the income measure of the income tax by virtue of P.L. 86-272 should evaluate the DOR's stated position with regard to the apportionment for purposes of the non-income tax measure of the corporate excise tax and consider whether there is a meaningful distinction between exemption under P.L. 86-272 and exclusion from income under a US tax treaty within the context of this TIR, and further, consider providing comments to the DOR if warranted.

———————————————

———————————————
ENDNOTES

¹ Depending on the mechanics of the state's "starting point" for computation of the tax base and conformity to federal taxable income, among other things.

² 830 CMR 63.38.1(7)(e).

³ See footnote 10 in the original TIR 10-16 and footnote 11 in the revised TIR.

⁴ Because P.L. 86-272 only applies to state income taxes.