Mississippi Rules that Denial of Deduction for Dividends Received from Out-of-State Subsidiaries is Unconstitutional
The Mississippi Supreme Court finds that the state’s denial of a dividend received deduction discriminated against interstate commerce, opening the door to refund opportunities.
In 1977, the U.S. Supreme Court, in Complete Auto Transit v. Brady, ruled that it was constitutionally permissible for states to tax companies engaged in interstate commerce provided that the tax met certain requirements.  The most well-known of those requirements is that the tax could not be imposed on a company that did not have nexus with the state. However, two other requirements, that the tax be fairly apportioned and that it not discriminate against interstate commerce, were put in place to make sure that state taxes do not overreach and that each state only tax its fair share. For example, a state would not be allowed to enforce a rule whereby the corporate income tax rate is higher for companies that have lower apportionment percentages, since that would penalize companies that engage in a greater amount of interstate commerce.
When courts strike down these provisions, it can often lead to a potential refund opportunity. Such is the case with a Mississippi Supreme Court (the “Court”) opinion issued on Oct. 27, 2016, that held unconstitutional the state’s denial of a dividend received deduction to a parent corporation where the subsidiary that paid the dividend did not do business in Mississippi. 
In the case, the Court was asked to examine the constitutionality of Mississippi Code Section 27-7-5(4)(i) which exempts from taxation “[i]ncome from dividends that has already borne a tax as dividend income under the provisions of this article, when such dividends may be specifically identified in the possession of the recipient.” The state interpreted that provision to allow the deduction only when the distributing corporation is doing business in the year of the distribution and files a Mississippi corporate income tax return for that year; no consideration is given to whether the distributing corporation’s income had already been taxed by any other state.
The Court struck down the statute as unconstitutional because it unfairly penalized businesses engaged in interstate commerce. In support of its conclusion, the Court put forth the following example: assume parent corporation A is doing business and files an income tax return in Mississippi. It has two subsidiaries: M, which does business and files a Mississippi income tax return, and N, which does not. M and N each earn $1,000, which is taxed at five percent (assume all state tax rates are five percent), and each make a distribution to A in the amount of $950. Mississippi taxes A on its $950 dividend from N but not from M, meaning that N’s $1,000 earnings are subject in Mississippi to a $50 tax at the subsidiary level, and then an additional $47.50 tax at the parent level, while M’s $1,000 is only subject to a $50 tax at the subsidiary level.
The basis for this disparate treatment was whether the subsidiary did business inside or outside Mississippi, with the state penalizing income and dividends from subsidiaries that did business outside the state. This violated fair apportionment principles and discriminated against interstate commerce in prohibition of the Commerce Clause of the U.S. Constitution.
The Court then had to determine how to remedy the situation. In other words, could it sever the problematic words or phrase from the statute without rendering the statute meaningless? Ultimately, it determined that the phrase “under the provisions of this article” was what gave rise to the disparate treatment based on geographic operations (i.e., dividends from subsidiaries that were already taxed in Mississippi were not taxed at the parent level, and dividends from subsidiaries not taxed in Mississippi were taxed at the parent level). By removing that phrase, the exemption for dividend income would be allowed if the subsidiary was taxed in Mississippi or any other state.
Taxpayers that have paid taxes on dividend income in Mississippi should examine whether such dividends would be eligible for an exemption under statute’s language as revised by the Court. If so, then a refund claim may be filed if within the applicable statute of limitations. Aprio’s SALT team can assist taxpayers with determining whether or not a refund claim is available, as well as filing and prosecuting such claim. We constantly monitor these and other important state tax issues, and we will include any significant developments in future issues of the Aprio SALT Newsletter.
This article was featured in the November/December 2016 SALT Newsletter. To view the newsletter, click here.
 430 U.S. 274 (1977).
 Mississippi v. AT&T Corp., No. 2015-CA-00600-SCT (Miss. Sup. Ct., Oct. 27, 2016).
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