Utah: Foreign Corporations Excluded from Water’s-Edge Group despite Section 1504(d) Election

In a case of first impression in Utah, an Administrative Law Judge (ALJ) addressed whether certain foreign corporations were required to be included in a Utah water’s-edge combined group. Under Utah law, corporations organized outside the U.S. whose activity in the U.S. is equal to or greater than 20 percent of the corporation’s total business activity are included in the water’s edge group. The corporations at issue did not have the requisite business activity in the U.S. However, on audit the Commission asserted that the income of the foreign corporations should be included because, for federal tax purposes, the taxpayer had elected under IRC section 1504(d) to treat the corporations as domestic entities included in the federal consolidated return. Furthermore, the income of these corporations was included on Line 28 of the federal return upon which Utah unadjusted income is based. In the Commission’s view, because unadjusted income starts with federal taxable income and the taxpayer had elected to treat the corporations as domestic entities for federal purposes, they should likewise be treated as domestic entities for Utah filing purposes.

The ALJ observed that the provisions indicating when foreign corporations are included in the water’s-edge combined report appeared to conflict with the definition of “unadjusted income” when there is a federal 1504(d) election in place.  Specifically, there was no guidance in Utah law as to what happens to the income of foreign entities that do not meet the threshold level of activity, but that are included in federal taxable income because of the election. Despite this and given that tax imposition statutes are to be constructed strictly in favor of the taxpayer, the ALJ concluded that the more specific provision of the law governing when a foreign corporation is included in the combined report because of its U.S. business activity should control. As such, the ALJ ruled that the income from the foreign corporations was not includable in computing the taxpayer’s Utah unadjusted income. Please contact Michael Larkin at   801-237-1335 with questions.