A foreign corporation and its wholly-owned subsidiary was recently denied a consolidated Kentucky corporation income tax return, as was found in World Acceptance Corporation and World Finance Corporation Kentucky v. Finance and Administration Cabinet Department of Revenue, K13-R-18, Kentucky Board of Tax Appeals (August 29, 2014). In the ruling, it was determined that parent corporation, World Acceptance Corporation, was not in an affiliated group because it had realized a net operating loss and its property, payroll and sales factors were de minimis.
Background and arguments
World Acceptance Corporation (WAC) filed a refund claim for overpayments of Kentucky corporate income taxes in the amount of $1,356,714 plus interest for the tax years ending March 31, 2007 through March 31, 2010. WAC argued that it was entitled to a refund because WAC and its wholly-owned subsidiary, World Finance Corporation Kentucky (WFCKY), are able to file a consolidated Kentucky return under Kentucky law.
The Kentucky Board of Tax Appeals (“Board”) had three issues to decide. First, whether an anonymous letter ruling submitted by WAC was binding on the Kentucky Department of Revenue (DOR). Second, if the DOR is not bound by the prior letter ruling, then the Board must decide which statutory definition of “includible corporation” applies for purposes of determining whether the parent corporation and its subsidiary may file a consolidated return. Third, analyze whether the parent corporation satisfies the applicable definition of “includible corporation.”
WAC based its claim for refund on an anonymous letter ruling by the DOR. The DOR letter ruling stated that the parent corporation (WAC) had nexus based on the facts presented in the letter and should file a consolidated return. However, the DOR reserved the right to change its decision if additional facts were presented. WAC’s claim for refund included specific information that management services provided by WAC would be performed outside of Kentucky, and explained that employees of WAC worked in other states besides Kentucky. The DOR contended that these facts were materially different from the facts presented in WAC’s request for the letter ruling, and altered the analysis.
The parties disagreed as to the controlling statutory definition of “includible corporation.” WAC argued that under the statutes set forth in KRS 141.200(9)(b), a consolidated return may be filed by an affiliated group if certain ownership criteria with respect to other includible corporations are met. The DOR argued that the definition of “includible corporation” found in KRS 141.200 (9)(e) is controlling because it expressly provides that this meaning should be applied in subsections (9) to (14) of that section. This statute defines an includible corporation as any corporation doing business in Kentucky except “[a]ny corporation that realizes a net operating loss whose Kentucky property, payroll and sales factors pursuant to KRS 141.120(8) are de minimis…” or any corporation for which the sum of all factors are zero.
WAC also argued that its payroll, property and sales factor in Kentucky are not de minimis regardless of the additional facts not provided in the letter ruling. WAC is a South Carolina corporation and had only one employee performing services in Kentucky. This employee was a resident of Tennessee, conducted auditing in various states, including Tennessee, and worked between 39 to 55 days in Kentucky during the years at issue. This employee received her assignments, schedules and payroll from the corporate headquarters in South Carolina, and used a car and laptop in Kentucky. The only sale WAC has in Kentucky is the management fee that WAC receives from WFCKY as compensation for the cost of management services performed by WAC in South Carolina.
Kentucky Board of Tax Appeals analysis and conclusions
The Board agreed with the DOR that the additional facts provided by WAC in its refund claim were material to and changed the outcome of the letter ruling, which relieved the DOR of being bound by its initial analysis and conclusions when reviewing WAC’s refund claim.
The Board also agreed with the DOR that the definition of “includible corporation” in KRS 141.200(9)(e) is controlling in analyzing whether a corporation is required to file a consolidated return because this section expressly provides that this definition should be applied in subsections (9) to (14) of that section.
When applying this definition, the Board determined that WAC had realized a net operating loss and that the Kentucky property, payroll and sales factors of WAC were de minimis. In reaching this conclusion, the Board analyzed each factor as follows:
- Payroll – WAC is required to have compensation “paid or payable” in Kentucky for there to be a numerator in the payroll factor. Pursuant to KRS 141.120(8)(b), compensation is paid or payable in Kentucky if:
- The individual’s service is performed in and outside of Kentucky, but the service performed outside Kentucky is incidental to the individual’s service within Kentucky; or
- Some of the service is performed in Kentucky and the base of operations or, if there is no base of operations, the place from which the service is directed or controlled is in Kentucky, or the base of operations or the place from which the service is directed or controlled is not in a state in which some part of the service is performed, but the individual resides in Kentucky.
- WAC’s sole employee in question worked only part of the year in Kentucky, performed essential audit services in Tennessee, where the employee resided, and was directed by WAC’s base of operations in South Carolina. Applying the statute, the Board sourced all of the employee’s compensation to Tennessee resulting in a Kentucky payroll factor of zero.
- Property – The Board found that only the laptop the employee used while in Kentucky can be included in the numerator of WAC’s property factor. Pursuant to regulation 103 KAR 16:290 Section 5(2), the car used by the employee would be allocated to the state in which the employee’s compensation is assigned under the payroll factor or to the state in which the car is registered, both of which in this case are Tennessee. By including only the laptop while it was in Kentucky in the numerator, the Board agreed with the DOR that the property factor was de minimis.
- Sales – The management fee was for accounting and administrative services, which were primarily performed at WAC’s headquarters in South Carolina. The Board found that under KRS 141.120(8)(c)(3), since a greater proportion of the income-producing activity is performed outside of Kentucky, the DOR appropriately sourced the management fee to South Carolina resulting in a zero sales factor.
Upon analyzing the additional information that management services were performed outside of Kentucky and that the employee worked in another state, the Board agreed with the DOR that the sourcing of the payroll and sales factors were changed resulting in a different conclusion than the conclusion originally reached in the DOR’s letter. The Board agreed with the DOR that WAC had a net operating loss and its Kentucky property, payroll and sales factors were de minimis. As a result, WAC is not an includible corporation under the applicable Kentucky tax statutes and could not file consolidated tax returns with its subsidiary to claim a refund for the years in question.
Lessons from WAC
This case demonstrates the importance of providing all the relevant facts when requesting a letter ruling from a governmental authority. When WAC requested a letter ruling, WAC failed to provide the DOR with all of the pertinent facts and acted on a faulty analysis in filing a refund claim. It is always imperative to provide all of the essential facts of a situation when requesting a legal analysis. Otherwise, your business may be in for a big surprise if supplementary facts result in a different outcome.