Massachusetts' Treatment of Sec. 338(h)(10) Election Provides Refund Opportunity

In Combustion Engineering, Inc., Mass. A.T.B. Docket F228740 (3/29/00), the Massachusetts Appellate Tax Board (Board) held that no portion of the gross proceeds or the gain realized from a deemed asset sale under Sec. 338(h)(10) was to be included in either the numerator or the denominator of the subsidiary's sales factor under state law.

In 1988, Combustion Engineering, Inc. (CEI) sold all of its stock in a subsidiary (Jamesbury) and made a joint election with the purchaser under Sec. 338(h)(10) to treat the sale as a deemed asset sale. As a result of the election, for Federal tax purposes, Jamesbury recognized a gain equal to the difference between the basis of its assets and their fair market value, and CEI recognized no gain on the sale of Jamesbury's stock. By virtue of a Sec. 338(h)(10) election, the transaction resulted in an allocation of Massachusetts income to the subsidiary and not the parent, as Massachusetts law defines net income by reference to the Code. While the transaction resulted in an allocation of income to the subsidiary, the Board concluded that, for sales-factor purposes, the receipts from the transaction were attributable to the parent.

For purposes of determining a corporation's sales factor, Massachusetts law (G.L. c. 63, section 38(f)) defines the term "sales" as the "gross receipts of the corporation except...gross receipts from the...disposition of securities." Although Massachusetts follows the Code when determining the starting point of a taxpayer's state tax base, the Board noted that "[t]he apportionment formula contained in G.L. c. 63, 38 makes no reference to the Code. Instead, this section defines the necessary terms. The statute is clear that receipts generated from the sale of stock are not 'sales' for purposes of the sales factor."

Accordingly, the Board found that the Federal treatment of the sale did not determine whether the proceeds of the transaction should be treated as "sales" for purposes of the apportionment formula and that, because the transaction was actually a stock sale, the proceeds should be excluded from the factor. The Board further noted that "[t]he Commissioner's regulation, 830 CMR 38.1(9)(b)7, promulgated in August, 1995, long after the 1988 transaction at issue and after the instant appeal was filed, is not persuasive on the issue of how 38 should be interpreted in this appeal."

In Technical Information Release (TIR) 01-11, the Massachusetts Department of Revenue explained the state's position on the Combustion Engineering decision. In light of the Board's determination and analysis, the Service will no longer enforce 830 CMR 63.38.1(9)(b)7 as it pertains to a Sec. 338(h)(10) election. Instead, it will treat the sales factor receipts from such transactions as belonging to the parent that sells the stock. The state will recognize the Board's decision in Combustion Engineering as applicable to open tax years, regardless of the fact that there may have been (depending on the timing of the transaction) a conflicting regulation in effect at the time the transaction took place. Accordingly, if a taxpayer contested the regulation and took the position that was ultimately upheld by Combustion Engineering, the state will now respect that interpretation (as long as the tax year in question remains open).

In addition, if the taxpayer complied with the regulation that was in effect to its detriment, Massachusetts will permit the taxpayer to rely on this TIR to the extent that the tax year in question remains open. Moreover, if the taxpayer relied on the regulation prior to the date of this TIR's issuance, and seeks to retain the treatment accorded to its transaction under the regulation, the state will respect that treatment. For this purpose, Massachusetts will presume that a taxpayer relied on the regulation as of the date of the transaction for which deemed sale treatment is subsequently elected.

From Karen J. Boucher, CPA, Milwaukee, WI