On July 9, 2019, the Supreme Court of Montana (court) held in Exxon Mobil Corporation ¹ that a domestic corporation could fully deduct dividends received from its 80/20 subsidiaries. The court's statutory construction analysis also serves an important reminder to first identify the effective federal income tax starting point and then focus on state-specific deductions.

Background

For its tax years 2008 through 2010, ExxonMobil filed its Montana combined returns with a water's-edge election. Accordingly, and as provided by the Montana water's-edge election statute, ExxonMobil excluded not only its foreign subsidiaries from its combined return but also certain domestic subsidiaries that were 80/20 corporations.² Members of ExxonMobil's water's-edge combined group received dividends from 80/20 corporations that were not included in the combined group and fully deducted those dividends in computing their Montana taxable income.

On audit, the Montana Department of Revenue (Department) determined that the members were only entitled to an 80% deduction for dividends received from the 80/20 corporations³ and issued an assessment of approximately $4 million in additional tax. On appeal, the Montana District Court upheld the Department's assessment and ExxonMobil appealed to the court.

Court's holding

The court observed preliminarily that the issues raised by this case dealt only with statutory construction. The court disagreed with the District Court's conclusion that the Department's interpretation of the statutes was entitled to deference. Based on certain prior holdings, the court determined no such deference was given, so the court had to determine if the law was correctly applied.

Moving to the substantive issue, the court observed that determining Montana taxable net income required corporations to first determine their gross income under the Internal Revenue Code (IRC). The corporation then adjusts its federal gross income using specifically enumerated items in the Montana statute. The court reaffirmed one of its prior holdings, Baker Bancorporation v. Montana Dept. of Rev., 202 Mont. 94, 98 (1982), which allows corporations to claim all available deductions under the IRC unless Montana law expressly provides otherwise.

Of particularly importance in this case, Montana Code Ann. (MCA) Section 15-31-325 addresses how certain dividends are treated. The statute provides:

For purposes of [MCA Sections]15-31-321 through 15-31-326, dividends must be treated as follows:

1. Dividends received from corporations incorporated outside the United States, to the extent taxable, are considered income subject to apportionment.
2. The after-tax net income of United States corporations excluded from eligibility as affiliated corporations under [MCA Section] 15-31-322(1) and possession corporations described in [Sections] 931 through 934 and 936 of the Internal Revenue Code are considered dividends received from corporations incorporated outside the United States.
3. Amounts included in income under [Sections] 951 through 962 and 964 of the Internal Revenue Code are considered dividends from corporations incorporated outside the United States.
4. Eighty percent of all dividends apportionable under this section must be excluded from income subject to apportionment.
5. "Deemed" distributions, as set forth in [Section] 78 of the Internal Revenue Code, and corresponding amounts with respect to dividends considered received under subsection (2) of this section must be excluded from the income of the water's-edge combined group.
6. The dividends apportionable under this section are in lieu of any expenses attributable to dividend income.
7. A dividend from a corporation required to be combined in the water's-edge combined group must be eliminated from the calculation of apportionable income.

The court addressed the Department's position that the prefatory language in Mont. Code Ann. Section 15-31-325 (i.e., "dividends must be treated as follows") evidenced a legislative intent to address all dividends received by a water's-edge group, precluding ExxonMobil from utilizing deductions authorized by IRC Section 243. Accordingly, the Department contended, ExxonMobil could only claim an 80% deduction under Montana Code Ann. Section 15-31-325(4). The court rejected the Department's reading of the statute, noting that it would have to "insert what has been omitted" into the framework of the Montana statute. The court noted that Mont. Code Ann. Section 15-31-325 addresses specific types of dividends apportionable under that section and that only those specifically enumerated dividends are subject to the 80% exclusion.

Because Mont. Code Ann. Section 15-31-325 did not expressly reference either IRC Section 243 or actual dividends received from 80/20 corporations, the court concluded that the legislature did not expressly prohibit other deductions expressly allowed by IRC Section 243. As such, the court concluded, ExxonMobil could still claim the deduction authorized under IRC Section 243. Since dividends received from a more-than-80%-owned domestic corporation (which would include an 80/20 corporation), would be eligible for a 100% deduction, ExxonMobil could deduct 100% of the dividends received from its 80/20 subsidiaries for Montana corporate income tax purposes.

Implications

Taxpayers filing Montana water's-edge returns should analyze any deductions they have taken for dividends received from 80/20 corporations on their past returns, consistent with the conclusions reached by the court in this case. Montana generally has a three-year statute of limitations for filing refund claims.

On a broader, multistate basis, taxpayers also may find this case instructive in defining the state income tax base. Generally, state statutes conform to federal taxable income as a starting point through a direct or implied reference to the IRC. This generally means that taxpayers can claim all federal deductions against gross income, unless the state statute expressly provides otherwise. Such a rendering of the state income tax base becomes particularly consequential in light of many new deductions provided by the Tax Cuts and Jobs Act (P.L. 115-97) (TCJA) enacted in December 2017. For example, many state tax laws both incorporate the new IRC Section 245A deduction for dividends received from a foreign corporation but also provide a state-specific deduction for dividends received from foreign corporations. State taxing authority interpretations may differ from this understanding of tax base construction, as expressed in their tax forms or other administrative guidance. The ExxonMobil case suggests that careful statutory construction could result in alternative, favorable filing positions under state law.

———————————————

———————————————
ENDNOTES

¹ Exxon Mobil Corp. v. Montana Dept. of Rev., 2019 MT 156 (Mont. S.Ct. July 9, 2019).

² Under Montana tax law, an 80/20 corporation is a domestic-incorporated entity for which less than 20% or less of its payroll and property is assignable to locations within the US.

³ ExxonMobil also claimed a deduction for 80% of the 80/20 corporations' after-tax net income under Montana Code Ann. Section 15-31-325(2). This deduction was not in dispute.