Michigan Tax Tribunal Rules that Subsidiary is Excluded from Unitary Business Group

By: Michael Colavito, SALT Director

At a glance

• The main takeaway: A recent Michigan Tax Tribunal decision highlights the type of subjective, facts and circumstances analysis that is used to determine whether two corporations are engaged in a unitary business.
• Assess the impact: The decision by the Tribunal sets a high bar and could provide guidance to other jurisdictions when performing a unitary business analysis.
• Take the next step: Aprio’s State and Local Tax (SALT) team can help analyze if your corporate group should be filing on a combined or unitary basis and ensure that it complies with all its state and local tax obligations.

Schedule a free consultation today to learn more!

The full story:

In TTI Inc. v. Michigan Department of Treasury, the Michigan Tax Tribunal (Tribunal) recently ruled in favor of a taxpayer that its wholly-owned subsidiary was not part of its unitary business group (UBG) because the two entities did not have business operations which resulted in a flow of value between the two and were not integrated with, dependent upon, and did not contribute to each other.¹ Despite the Michigan Department of Treasury’s (Department) painstaking focus on a few facts that might have suggested the Tribunal would rule in its favor, the Tribunal concluded that a UBG did not exist under Michigan Corporate Income Tax (CIT) law.

A closer look at the case

A corporation that is subject to Michigan’s CIT that is part of a UBG with other corporations, must file its CIT return on a combined basis and include the net income of all members of the UBG. The taxpayer and its subsidiary both sold electronic components but had different customer bases. The taxpayer’s business consisted of high volume and large quantity sales, whereas the subsidiary serviced the engineering community that made purchases in small quantities. During the tax periods at issue, the businesses shared two common officers. In addition, the taxpayer and the subsidiary engaged in intercompany sales with the taxpayer making sales to the subsidiary on average of $20 million annually, and the subsidiary having sales to the taxpayer of about $1.5 million annually. However, these sales only accounted for approximately 1.5% of each business’ annual revenue. The two businesses also had a common 401(k) retirement savings plan, worker’s compensation plan, health insurance plan, and business insurance policy. However, uncontroverted testimony of the taxpayer’s CEO reflected that these common policies did not result in a costs savings for either business. 

From an operational perspective, the taxpayer was required to approve capital expenditures of the subsidiary that were greater than $1 million. However, neither company established goals or formulated policies, approved or signed contracts, participated in management decisions, or made purchases for the other. The taxpayer and the subsidiary also had separate personnel, separate hiring policies, did not advance money to each other by direct loans, and did not pay rent or other expenses to the other.

Unpacking the Court’s ruling

The Tribunal was tasked with applying these facts to the state’s definition of a UBG. For a UBG to exist, the entities at issue must meet both a control test and a relationship test. Due to the taxpayer’s 100% ownership of the subsidiary, the control test was clearly met. Thus, the only issue in the case was whether the relationship test was met between the two businesses. 

Under the CIT, the UBG relationship test is met if two or more corporations have business activities or operations which either:

• Result in a flow of value between or among the corporations, or
• Are integrated with, are dependent upon, or contribute to each other. 

The Department’s published guidance on the UBG relationship test provides an explanation of the flow of value test that is based on the U.S. Supreme Court’s decision in Container Corp. of America v. Franchise Board.² In Container, the Court described that a flow of value occurs between businesses when contributions to income result in “functional integration,” “centralization of management,” and “economies of scale.” The Tribunal considered each of these factors and concluded that none of them existed in any significant way between the taxpayers and the subsidiary. 

First, the Tribunal reasoned that the two businesses were not functionally integrated. The intercompany sales were deemed not significant when compared to the overall sales of each business and did not result in a cost savings for either company. Further, the taxpayer’s testimony also established that intercompany sales were only initiated if either business was unable to obtain the products from their distributors. Finally, the companies had separate purchasing, facilities, operations and distribution systems.

Second, the Tribunal also concluded that the two businesses were “nearly devoid” of centralized management. The record showed that the taxpayer had minimal oversight of the subsidiary, and the authorization of capital expenditures of over a $1 million was an informal process typically provided verbally to the subsidiary. The Tribunal also observed that dozens of business functions were duplicated through separate business operations in the areas of human resources, finance and accounting, purchasing and facilities.

Finally, the decision similarly concluded that the relationship between the companies did not result in any significant economies of scale. Again, essential business functions were duplicated between the two companies. Further, the evidence supported that the common 401(k), worker’s compensation, health insurance and business insurance plans did not result in any cost savings.

The Tribunal next considered whether the companies’ relationship satisfied the alternative “contribution/dependency” relationship test, which requires that the businesses are:

• Integrated with,
• Dependent upon, or
• Contribute to each other. 

Notably, the alternative relationship test will be met if only one of these factors is found to exist. 

In analyzing these factors, the Tribunal seemed to struggle with, and rightfully so, distinguishing between these two alternatives for satisfying the relationship test. Notably, the decision points out that there is nothing in the statute or the Department’s published guidance indicating any difference between the flow of value and functional integration factor and the integration analysis that is part of the “contribution/dependency” test. Thus, the Tribunal reasoned that the businesses were not integrated. In fact, even when analyzing whether the taxpayer and subsidiary were dependent upon or contributed to each other, the Tribunal concluded that neither of these factors were satisfied on similar grounds to the findings discussed above regarding a lack of centralized management and economies of scale. 

The bottom line

The decision is certainly instructive with respect to the unitary business analysis in Michigan with the Tribunal seemingly setting a somewhat high bar for each of the relevant factors, and steering clear of interpreting the “contribution/dependency” relationship test as being more easily satisfied than the flow of value test. Although the Tribunal’s analysis could provide guidance to other jurisdictions in applying the factors considered in performing a unitary business analysis, chances are that other states could examine very similar facts and reach the opposite conclusion. 

The existence of a unitary business relationship invariably involves a somewhat subjective analysis that is dependent on the facts and circumstances of each case with no one factor being determinative. Yet the analysis is critical to both a taxpayer’s ability to apportion business income within and without a state and, for the majority of state corporate income taxes, determining whether a taxpayer is required to file a separate return or a combined return that includes the net income or related corporations. 

Aprio’s SALT team has experience advising clients on a wide range of state and local tax matters, including whether your corporate group should be filing on a combined or unitary basis. We can assist your business to ensure that it complies with all its state and local tax obligations as well as recommend alternative structures that may minimize these liabilities. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

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¹ TTI Inc. v. Michigan Department of Treasury, Mich. Tax Tribunal, Dkt. No. 21-002481, 10/17/2023.

² 463 U.S. 159 (1983).