Michigan's new corporate income tax - the road ahead.

• Author: Gandhi, Lynn A.

A Vow to Abolish the Michigan Business Tax

In 2010, as the gubernatorial election in Michigan began in earnest, Rick Synder, a candidate for the Republication nomination, pledged to abolish the Michigan Business Tax (MBT). Snyder, a successful businessman, believed that to improve the business climate in Michigan, it was necessary to eliminate the MBT, a complicated and unique tax, which was top heavy with specialized incentives and credits.

At the time, several proposals were floating around Lansing to reduce the effective tax rate on businesses, including eliminating the MBT surcharge, eliminating the modified gross receipts levy under the MBT, and reducing the effective rate of the MBT. In illuminating his differences from the Granholm administration, Rick Snyder declared he would not tinker with the MBT. Rather, he said its elimination would be crucial to remaking the state.

Governor Snyder won by a wide margin, swept into office by the deep dissatisfaction felt by Michigan residents as one of the states hardest hit by the recession. Vowing to introduce a new tax regime and a two-year budget plan well before the required June 1, 2011 deadline, Governor Snyder appointed as the state's new Treasurer the former Speaker of the House, Andy Dillon, a Democrat who had been instrumental in the passage of the MBT. Treasurer Dillon was now to oversee the replacement of the MBT with a new tax regime.

In late spring of 2011, as part of his proposed budget) Governor Snyder revealed his tax plans. The MBT was to be replaced with a simple corporate income tax at the rate of 6 percent. Only Subchapter C corporations would be subject to the tax; there would be no corporate level tax on other forms of entity. In addition, significant changes were proposed to the Individual Income Tax Act (IITA), placing more of the revenue burden on Michigan citizens. While the IITA rate was not increased, (2) deductions and credits were removed or heavily restricted. The exemption permitted for public pension distributions was severely limited, subjecting retirement income to tax, albeit with a sizable exemption allowance. (3) In order to offset the shortfall in revenue owing to the elimination of the MBT, the Governor successfully proposed a 1-percent tax on health care claims made (4) and took action to renegotiate state employee contracts. Overall, relief to the business community from the Governor's proposal is estimated to be nearly a billion dollars. The overriding intent was to increase Michigan's attractiveness as a place to do business.

The Michigan Corporate Income Tax

The Michigan Corporate Income Tax (CIT) continues many of the attributes of the MBT, while providing several new key provisions that require review and implementation measures before the January 1, 2012, effective date of the tax.

Entities Subject To Tax

Every taxpayer with nexus conducting business activity within Michigan is subject to the tax. In addition, under the CIT, any person with an ownership interest or beneficial interest in a flow-through entity that has business activity in the state will also be deemed to be subject to tax. The tax is levied at a rate of 6 percent. (5) The tax is only applicable to C-corporations and unitary business groups. "Corporation" is defined as a taxpayer that has elected or is required to file as a C corporation as defined under sections 1361(a)(2) and 7701(A)(3) of the Internal Revenue Code (the Code). (6) For the first time since 1976, flow-through entities (partnerships, limited liability companies, and S-corporations) will not be subject to an entity level business tax in Michigan. Instead, the income of flow-through entities is only subject to a single level of tax at the partner or shareholder level. Insurance companies continue to be subject to the gross premiums tax similar to that imposed under the MBT (7) and financial institutions remain subject to a net capital tax, also similar to that imposed under the MBT. (8)

Interestingly, while the income of flow-through entities may still be included in the tax base of corporate members, the statute does not provide for inclusion of the flow-through entity's factors in the apportionment factor of the corporate member. An open question under the CIT is whether all distributions from flow-through entities are properly includible in the tax base of a corporate member; this is especially the case for distributions related to passive investments or for which there is no flow of value between the flow through entity and its member. (9)

Unitary Business Group and Mandatory Combined Filing Requirement

The CIT continues the imposition of tax on a unitary business group with the mandatory combined filing methodology that came into force with the passage of the MBT. (10) The state's purpose in adopting mandatory unitary business group filing was to prevent the perceived tax planning among members of an affiliated group. Under the CIT, a unitary business group may include corporations (including those partnerships and limited liability companies taxed as corporations) as well as insurance companies and financial institutions. Although insurance companies and financial institutions are not subject to the CIT, inclusion of these entities in the unitary business group ensures that calculation of the unitary business group tax base excludes intercompany transactions. Unitary under the CIT is determined on a water's-edge basis, excluding foreign companies from the unitary group. A unitary business group must be constituted of United States persons. A United States person is defined as "meaning the same as under IRC Section 7701(A)(30)." Foreign operating entities, as specifically defined in the CIT, are not eligible for inclusion in the unitary business group. (11)

The CIT defines a unitary business group as "a group of U.S. persons, other than a foreign operating entity, one of which owns or controls more than 50% ownership interest with voting rights or the equivalent of voting rights." (12) In addition, there must be business activities or operations that create a flow of value or contribution and dependency between or among the corporations in the unitary group. Thus, a unitary business group must meet the control test and one of two alternative relationship tests: (1) the flow of value test, or (2) the integration, dependency, or contribution test. Previously, the Michigan Department of Revenue issued nonbinding Revenue Administrative Bulletins (13) and frequently asked questions and answers (FAQ) (14) to provide guidance on the application of these tests and the composition of the unitary business group under the MBT. Given the similar statutory definition of a unitary business group, this guidance will likely apply to the unitary business group determinations under the CIT,

Control Test. Under the control test, one member of the unitary business group must own or control more than a 50-percent ownership interest with voting rights or the equivalent of voting rights. (15) In Revenue Administrative Bulletin 2010-1, Michigan Business Tax Unitary Business Group Control Test, the Department of Revenue concluded that a person owns or controls more than 50 percent of the ownership interests with voting rights if that person owns or controls, directly or indirectly, (1) more than 50 percent of the total combined voting power of all ownership interests with voting rights or (2) more than 50 percent of the total value of all ownership interests with voting rights. The Department said that an ownership interest with comparable rights to voting rights is one that confers the power to vote in the selection of the management of the entity. In Revenue Administrative Bulletin 2010-1, the Department explained that Parent-Subsidiary and Brother-Sister controlled group of entities will meet the control test where there is more than 50-percent ownership. (16) The Department has also stated that brother-sister entities may constitute a unitary business group, even if the owners are not included in the group. (17) The Department applied section 1563(c) of the Code, except for subparagraph (c)(2) (B), to exclude certain ownership interests from the determination of the control test.

The Department has previously applied rules similar to the federal attribution rules to ownership interests among immediate family members and between corporations and their shareholders to determine control of a unitary business group. Under the Department's interpretation, an individual is deemed to constructively own the ownership interests of his spouse, children, grandchildren, and parents. In addition, a shareholder who owns more than 50 percent in value of the stock of a corporation is considered to own all stock owned...