Designing a Combined Reporting Regime for a State Corporate Income Tax: A Case Study of Louisiana

• Author: Michael J. McIntyre; Paull Mines; Richard D. Pompx
• Position: Professor of Law, Wayne State University; General Counsel, Multistate Tax Commission; Alva P. Loiselle Professor of Law

The authors thank members of the California and Louisiana tax departments, particularly Mike Brownell, Ben Miller, and Mike Pearson, for helpful comments on portions of this article.

The views expressed by the authors in this Article do not necessarily represent the views of the organizations with which they are associated. Indeed, in some instances, the views do not necessarily represent the unanimous views of the individual authors, notwithstanding their common commitment to the major reform goals advocated here. In some instances, they fashioned mutually acceptable compromises to reach a consensus position.

Professor of Law, Wayne State University; A.B., Providence, 1964; J.D. Harvard Law School, 1969.

General Counsel, Multistate Tax Commission; B.A., University of Washington, 1964; L.L.B., Harvard Law School, 1967; L.L.M., New York University, 1985.

Alva P. Loiselle Professor of Law, University of Connecticut Law School; B.S. University of Michigan, 1967; J.D. Harvard Law School, 1972.

I Introduction

This article presents a plan for revitalizing the Louisiana corporate income tax through the adoption of a combined reporting regime. Our plan would require affiliated companies engaged in a unitary business in the State to pay their Louisiana income tax based on an apportioned share of their combined income. Combined reporting is the only effective way for any state to impose a fair and uniform corporation income tax on multistate and multinational enterprises and to gain or maintain control over its own tax base. The current Louisiana corporate income tax is subject to abuse through tax planning techniques that are very familiar to members of the tax- avoidance community. California and other states that have adopted combined reporting have demonstrated that combined reporting fairly and effectively responds to most of these common tax avoidance techniques.

Part II, below, discusses the potential benefits inuring to Louisiana from adopting a combined reporting regime. Those benefits are not mere speculation. California has been operating a combined reporting system successfully for nearly seven decades. In brief, the benefits are a uniform treatment of corporate groups without regard for differences in their organizational structure, a strong bulwark against the use of tax-haven jurisdictions to avoid state taxation, a significant reduction in administrative burdens on the tax department and on complying taxpayers, and the removal of the competitive disadvantage currently imposed on local firms that are unable to engage in cross-border tax-avoidance.

In Part III, we address some basic issues in the design of an effective combined reporting regime. One of the important features of combined reporting is the use of a formula to apportion the unitary business income of a unitary enterprise between Louisiana and the rest of the relevant universe. Louisiana already uses formulary apportionment in its current corporate tax system. To operate a combined reporting regime, however, Louisiana must apply that formula not to the separate income of each corporation but to the combined income of a corporate group engaged in a unitary business in Louisiana. Yielding to political realities, we recommend that Louisiana offer companies a water's edge election that would allow them to exclude from their combined report the income derived by certain foreign affiliates that do not have an obvious close tie to the unitary business conducted in Louisiana.

Part IV addresses a variety of technical issues that Louisiana should address when adopting a combined reporting regime. We offer our views on how those issues should be resolved, drawing, when appropriate, on the experience of other combined-reporting states. Some of these issues relate to potential transition problems. Other issues relate to practical problems of assessing and collecting a tax from corporations operating in Louisiana on income that is computed by reference to the combined income of a unitary group. A brief conclusion is presented in Part V.

In adopting a combined reporting regime, we recommend that Louisiana follow the well-marked trail forged by California and other combined- reporting states. Those states have solved many technical difficulties and have won many important victories in the courts.¹ We see no good reason why Louisiana should fight those battles anew by introducing untested provisions into its combined reporting regime. We also strongly favor uniform state taxing rules, and uniformity is obviously enhanced when states borrow from the successful experiments of sister states. We do not suggest, however, that Louisiana should avoid innovation when the experience of the combined-reporting states has been unhappy. The combined-reporting regime we recommend, if adopted by Louisiana, would have a definite Cajun flavor.

II Benefits of Combined Reporting

Louisiana has long employed a system of formulary apportionment for determining the Louisiana taxable income of a corporation that is operating within and without Louisiana through multiple divisions or branches. In adopting formulary apportionment, the Louisiana Legislature has implicitly concluded that apportioning income by payroll, property, and receipts (sales) is superior, as a system of tax accounting, to a system based on the separate transactions of the taxpayer, as reflected on its books of account. The case for combined reporting is a logical extension of the case for apportioning by formula the business income of an individual corporation. The rationale of both cases is that the substance of the business activities in the state should control, not the organizational structure of the business entity or entities conducting those activities. That is, whether a business enterprise chooses to have numerous divisions or whether it chooses to incorporate those divisions and operate them as subsidiaries should have as little impact as feasible on the amount of Louisiana income tax paid by that enterprise.

The U.S. Supreme Court has acknowledged that combined reporting is both a better method for measuring the income of a unitary business and a safeguard against taxpayer manipulation:

The problem with [formal geographical or transactional accounting, including separate accounting] is that formal accounting is subject to manipulation and imprecision, and often ignores or captures inadequately the many subtle and largely unquantifiable transfers of value that take place among the components of a single enterprise. The unitary business/formula apportionment method is a very different approach to the problem of taxing businesses operating in more than one jurisdiction. It rejects geographical or transactional accounting, and instead calculates the local tax base by first defining the scope of the "unitary business" of which the taxed enterprise's activities in the taxing jurisdiction form one part, and then apportioning the total income of that "unitary business" between the taxing jurisdiction and the rest of the world on the basis of a formula taking into account objective measures of the corporation's activities within and without the jurisdiction.²

Section II.A., below, presents support for the U.S. Supreme Court's assertion that combined reporting is a superior method for determining the in-state income of a member of a unitary group of corporations. In Section II.B., we explain how a combined reporting regime protects a state against various tax-avoidance techniques that multistate companies routinely use to lower their tax bills in separate reporting states. Section II.C., examines the potential of combined reporting for simplifying the Louisiana corporate income tax.

Our recommendation that Louisiana adopt combined reporting does not mean that we would eliminate the use of the separate accounting method entirely. Louisiana law currently permits taxpayers to apply to the tax department for permission to use separate accounting under certain conditions "if the taxpayer shows that the apportionment method produces a manifestly unfair result."³ We would...