Unitary Taxation

Apportionment is the division of an entity’s income between all states in which it has a presence. The unitary-business principle attempts to prevent entities from shielding income from apportionment by dropping an income-producing business division into one or more subsidiaries that operate in different states from the parent. Under the unitary-business principle, if a subsidiary operates as an integrated division of a single, unitary business with the parent, then income apportionment should focus on the income of the entire unitary business, not the income of the parent or subsidiary alone (this often results in the subsidiary’s income being taxed by states in which the parent entity is present).

The unitary-business principle is derived from United States Supreme Court decisions. States may adopt contrary interpretations of these opinions. See F.W. Woolworth v. Tax & Rev. Dep’t of N.M, 458 U.S. 452 (1982), Exxon Corp. v. Dep’t of Rev. of WI, 447 U.S. 207, 223-24 (1980), Mobil Oil Corp. v. Com’r, 445 U.S. 425, 441-42, 439 (1980), and Asarco Inc. v. ID State Tax Com’n, 458 U.S. 307, 322-23 (1982).

A common line of business / industry between a parent and subsidiary would not itself generate a unitary business. Rather, a unitary business arises if, examining the parties’ underlying economic realities, subsidiaries’ income is not in fact “derive[d] from ‘unrelated business activity’ which constitutes a ‘discrete business enterprise’” from the parent. The hallmarks of a unitary business are functional integration, centralized management, and economies of scale. Some specific factors that would help a taxpayer avoid unitary business between two entities include:

1. Different business models.
2. Different organizational features or business structures (e.g., one entity has a 24-hour toll free contact line; the other entity does not speak with the public).
3. Lack of vertical integration. If the subsidiary can call the parent for tech support, troubleshooting, or detailed specific business advice, such integration may demonstrate a unitary business.
4. Lack of a centralized management structure (e.g., different managers, officers, directors). Some overlap is not fatal, but tends to demonstrate a unitary business.
5. No joint discussions on major financial decisions, such as dividends, the parties’ overall capital structure, or borrowing decisions. Some level of joint decision-making can be excused as normal parent-subsidiary stewardship.
6. Lack of economy of scale principles (e.g., the entities do not join their business needs to produce greater volume or clout and secure lower prices).
7. No centralized personnel training or rotation.
8. No shared lawyers, accountants, warehousing, or financing sources.
9. No other functional integration between parent and sub (no shared vehicles, etc.).
10. No department or section in the parent devoted to overseeing the subsidiary.
11. No consolidated tax returns or financial statements.

The above list is not exhaustive, but represents common activities relevant to the unitary-business analysis.

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Roger Royse
rroyse@rroyselaw.com

Roger Royse, the founder of the Royse Law Firm, works with companies ranging from newly formed tech startups to publicly traded multinationals in a variety of industries. Roger regularly advises on complex tax structuring, high stakes business negotiations and large international financial transactions. Practicing business and tax law since 1984, Roger’s background includes work with prominent San Francisco Bay area law firms, as well as Milbank, Tweed, Hadley and McCloy in New York City. Read My Full Bio

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