State & Local Tax Alert - Grant Thornton LLP

State & Local Tax Alert
Breaking state and local tax developments from Grant Thornton LLP
Missouri Administrative Hearing Commission Holds Intercompany
Dividends are Excluded from Sales Factor Denominator
On October 17, the Missouri Administrative Hearing Commission (AHC) held that
dividends paid to a parent corporation and its subsidiaries by affiliates that were part of
the same consolidated group were required to be excluded from the sales factor
denominator because the facts failed to determine the amount of dividends that arose
from operations in Missouri, and the inclusion of dividends only in the sales factor
denominator would prevent the fair operation of the apportionment formula. 1
Background
The taxpayer, a Missouri holding company that provided telecommunication services
through its subsidiaries, elected to file a Missouri consolidated income tax return 2 with its
subsidiaries using a three-factor method of income apportionment for a short taxable year
beginning May 18, 2006 and ending December 31, 2006. For purposes of apportionment,
the taxpayer included $1,276,822,176 in dividends paid to the taxpayer and its subsidiaries
by other affiliated companies (local exchange carriers) in the consolidated group in its sales
apportionment denominator. The taxpayer recorded these dividends as “cash
distributions” which were not considered to be the sales of goods or services by the payers
or recipients.
In 2008, the Missouri Department of Revenue’s Field Compliance Bureau (“Bureau”)
began an audit of the taxpayer’s 2006 tax year and adjusted the sales factor denominator to
exclude the dividends paid by affiliates from the sales factor denominator. The Bureau
issued a Notice of Deficiency, assessing an additional amount of $74,924.45 (including
interest and penalties), the vast majority of which was a result of the audit adjustment that
excluded the dividends paid by affiliates from the sales factor denominator. The taxpayer
appealed the Notice directly to the AHC. The sole issue before the AHC was whether the
dividends paid by the taxpayer’s affiliated companies should be included in the sales factor
denominator.
Release date
December 6, 2012
States
Missouri
Issue/Topic
Corporation Income Tax
Contact details
Carolyn Harpole
St. Louis
T 314.735.2121
E carolyn.harpole@us.gt.com
Roy Tegenkamp
Kansas City
T 816.412.2629
E roy.tegenkamp@us.gt.com
Giles Sutton
Charlotte
T 704.632.6885
E giles.sutton@us.gt.com
Jamie C. Yesnowitz
Washington, DC
T 202.521.1504
E jamie.yesnowitz@us.gt.com
Chuck Jones
Chicago
T 312.602.8517
E chuck.jones@us.gt.com
Hannah Yoo
Chicago
T 312.602.8338
E hannah.yoo@us.gt.com
www.GrantThornton.com/SALT
1 Embarq Corp. v. Department of Revenue, Missouri Administrative Hearing Commission, No. 10-1485
RI, October 17, 2012.
2 The affiliated companies participating in the Missouri consolidated income tax return were
identical to the companies participating in the taxpayer’s federal consolidated return.

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Dividends Not Included in Sales Factor Denominator Under Intercompany
Transaction Regulation
A Missouri regulation defines the term “sales and business transactions” to include all
intercompany sales (business transactions as defined in Treas. Reg. Section 1.1502-13
(relating to federal consolidated reporting of intercompany transactions). 3 Relying on this
regulation, the taxpayer argued that the dividends from affiliates were distributions with
respect to stock between members of the same consolidated group, and as a result, they
constituted “intercompany transactions” that should be included in the sales factor
denominator.
Since the issue raised by the taxpayer was a matter of first impression in Missouri, the
AHC considered precedent from other states. The AHC ultimately gave weight to a
Florida court decision to determine that dividends were not includable in the sales factor
denominator under the regulation relied upon by the taxpayer. The Director had
presented the AHC with Department of Revenue v. Anheuser-Busch, Inc. 4 due to the fact that
Florida had a similar intercompany transaction regulation. In Anheuser-Busch, Inc., the
transactions were deemed intercompany transactions because there were indicia of sales,
such as an invoice from the subsidiary to the parent company and delivery of the sold
items from the subsidiary to the parent company. In the present case, however, the
taxpayer recorded the dividends as cash distributions, and not the sales of goods or
services. Due to this distinction, the AHC found that the dividends were not includable in
the sales factor denominator as “intercompany transactions” under the regulation cited by
the taxpayer.
Inclusion of Dividends in Sales Factor Denominator Resulted in Unfair
Apportionment
While the dividend was not includible pursuant to the regulation addressing intercompany
transactions, a second regulation addressing exceptions and special rules applicable to the
sales factor was analyzed as well. 5 Under this regulation, the Department contended that
the income from the dividends resulted from the mere holding of intangible personal
property and could not be attributed to any particular income-producing activity of the
taxpayer. As such, the dividend income could not be includible in the sales factor
denominator. The taxpayer argued that this exclusion rule only applied to passively held
stocks or stocks that are “merely held” and not to its dividends, which were business
income from income-producing activities.
To bolster its argument, the taxpayer presented Legal Ruling 2003-3 issued by the California
Franchise Tax Board (FTB). 6 In that ruling, the FTB was confronted with regulatory
language that was very similar to the regulatory language at issue and decided that business
3 MO. CODE REGS. ANN. tit. 12, § 10-2.045(19).
4 Department of Revenue v. Anheuser-Busch, Inc., 527 So.2d 877 (Fla.1 st DCA 1988).
5 MO. CODE REGS. ANN. tit. 12, § 10-2.075(43) and (57); MO. CODE REGS. ANN. tit. 12, § 10-
2.075(64)(C).
6 Franchise Tax Board Legal Ruling 2003-3, December 4, 2003.

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income dividends were gross receipts as long as they represent more than just the holding
of intangible property. Applying this ruling to the case at hand, the AHC found that the
taxpayer’s participation in management and operations of other affiliated companies
showed that the dividends were gross receipts qualified to be included in the sales factor
denominator under the specific regulatory provisions addressing income-producing
activity.
However, the Department also contended that including the taxpayer’s dividends in the
sales factor denominator would effectuate unfair apportionment under the regulations. 7
Pursuant to this argument, the Missouri-sourced dividends could not be separately
identified since there were not enough facts to establish the dividends that arose from
operations taking place in Missouri versus operations taking place elsewhere, and as such,
this prevented fair apportionment. The AHC agreed with the Department’s position,
excluding the dividends from the sales factor denominator, and upheld the assessment
against the taxpayer.
Commentary
Missouri permits taxpayers, under certain circumstances, to include the effect of
intercompany transactions in the sales factor. In this case, however, the AHC denied
application of the intercompany transaction regulation used by the taxpayer in support of
its argument. While this regulation was unavailable to the taxpayer, the AHC ultimately
based its exclusion of the dividends from the sales factor on a different ground. The lack
of factual support to identify the dividends that arose from Missouri operations, and
therefore, the inclusion of dividends in the sales factor denominator, prevented the fair
apportionment of income in the eyes of the AHC.
Significantly, the AHC appears to suggest that had the taxpayer been able to separately
identify the dividends arising from Missouri, the taxpayer would have been able to include
the dividends in the apportionment factor. This would have been a positive development
for the taxpayer if the dividends could be sourced entirely outside of Missouri, as the
inclusion of such dividends solely in the denominator of the sales factor would have
reduced the taxpayer’s apportionment percentage to Missouri.
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7 MO. CODE REGS. ANN. tit. 12, § 10-2.075(43).

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