Massachusetts rules on taxing capital gains of out-of-state corporation
On May 16, 2022, the Supreme Judicial Court of Massachusetts (court) ruled against the Massachusetts Department of Revenue Commissioner (commissioner) in a case involving the taxability of capital gains received by an out-of-state company from the sale of its interest in a Massachusetts limited liability company. In VAS Holdings & Investments LLC v. Commissioner of Revenue, Mass. S. Ct., Dkt. No. SJC-13139, 05/16/2022, the court reversed the prior decision of the Appellate Tax Board, holding that the commissioner did not have the statutory right to tax the capital gain.
VAS Holdings & Investments LLC (“VASHI”) is a Florida-based S-corporation that sold its interest in Massachusetts-based Cloud5 LLC (Cloud5) in 2013, realizing a capital gain of $37 million. The commissioner had assessed tax on VASHI, which the Appellate Tax Board upheld. The court’s decision this week reversed the prior decisions on the basis that there was no statutory authority for the tax assessment.
What does this mean?
The court’s decision examined the applicability of two Massachusetts taxes to VASHI. First, the corporate excise tax was determined not to be applicable because VASHI and Cloud5 were not found to operate as a single unitary business. Addressing the adoption of unitary principles by the Massachusetts legislature, the decision states, “these statutes establish that the Legislature has chosen to adhere to the unitary business principle in formulating its taxing policy”. Under Massachusetts law, businesses are held to be unitary when the following factors exist: functional integration, centralization of management, and economies of scale. Income can also be included and taxed in a unitary group where it serves an operational function in the business. In applying unitary business standards under state law, the court had determined that none of these factors existed between VASHI and Cloud5 that would render them as operating as a single unitary business warranting a state corporate excise tax obligation on the recognized gain.
Second, the nonresident composite tax was held inapplicable because VASHI did not carry on any trade or business in Massachusetts, as required by Mass. G.L. c.62, Section 5A. This determination was made despite the commissioner’s citation of Example (3)(c)(8.1) of 830 Code Mass. Regs. § 62.5A.1(3)(c)(8), which states that Massachusetts source income includes gain from the sale of a business (carried on in Massachusetts) by a nonresident, even where the nonresident partner had no involvement in the management or operations of the business. As pointed out by the court in its decision, “VASHI does not carry on a trade or business in Massachusetts.”
This recent decision illustrates Massachusetts’ position with respect to gains derived by out-of-state member/owners from their disposition of ownership interests in Massachusetts-based companies where a unitary business relationship is lacking between the member/owner and the disposed pass-through business entity company. To the extent Massachusetts returns have been prepared taking a contrary position (i.e., sourcing such gain to Massachusetts) under similar facts, the filing of amended returns for refund should be considered.
Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice specific to, among other things, your individual facts, circumstances and jurisdiction. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
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