Ousted! “League Commissioner” ejects affiliated companies from Taxpayer’s consolidated income tax reporting team due to insufficient Indiana “on-court” presence (or Nexus)

The Indiana Department of Revenue (in the spirit of this posting, the “League Commissioner” or just “Commissioner”) determined that two affiliated companies should not have been on the same team as the Indiana Taxpayer and removed them from the Taxpayer’s consolidated income tax return, i.e. the Commissioner not only ejected the affiliated companies from the game but effectively kicked them off the team.  The League Commissioner’s Letter of Findings No. 02-20110301 (posted April 25, 2012) blandly labels the parties as Taxpayer and its affiliates as Member A and Member B.  Because this is Indiana and the Pacers have – after a long dry spell – reached the second round of the NBA playoffs, I will refer to Taxpayer as the Pacers, Member A as the Magic (the Pacers defeated first round foe) and Member B as the Heat (their second round opponent).  Pacers are a corporation doing business in Indiana.  As the result of an audit, the Commissioner removed the Magic and Heat from the Pacers’ consolidated income tax return, claiming that the two affiliated “teams” did not play (do business) in Indiana.  As a result, the Commissioner imposed a fine (assessment) for the 2007 season (tax year).  (Technically, only the Magic were removed from the consolidated return for 2007; the Heat were removed for prior seasons, which impacted the net operating loss carryforwards from these years to 2007.)

Pacers argued that the Magic and Heat should be included in a consolidated return, as part of the Filing Group, for two reasons.  First, the Pacers contended that a prior settlement agreement required the Commissioner to allow the Pacers to include the Magic and Heat in the Pacers’ consolidated group.  Second, the Pacers asserted that both of its affiliated “teams” had sufficient Hoosier contacts to permit them to travel on the same “team bus” and file a consolidated Indiana corporate income tax return.  Stated differently, the Pacers argued that the affiliated “teams” had sufficient nexus with Indiana.  (A final issue raised by the Pacers, involving the recalculation of a research expense credit, is not discussed in this post.)

Settlement agreement did not require consolidated return to include affiliates.  As to the first issue, the settlement agreement at issue is not in the record but relates to the Pacers’ challenge of an audit for prior years that was settled following an appeal to the Indiana Tax Court.  In the prior assessment and protest, which also involved the removal of affiliates from a consolidated return, the Pacers argued that its affiliates had nexus with Indiana and that, in the alternative, the Pacers should have been permitted to file a combined return.  The League Commissioner concluded that the referenced settlement “permitted a consolidated return under IC § 6-3-4-14 [the statute authorizing consolidated returns by affiliated corporations with income derived from Indiana sources], subject to the conditions set forth in IC § 6-3-4-14, rather than a consolidated return including companies that did not conduct business in Indiana.”  In short, the Commissioner concluded that the settlement of the prior protest involved the same rules in play as in the current protest – which require affiliated teams to “have adjusted gross income derived from sources within the state of Indiana” to be included on a consolidated return.  See Ind. Code § 6-3-4-14(b).  The prior settlement, accordingly, did not require the Commissioner to permit a consolidated return for the three “teams” for 2007.

Evidence failed to show that affiliate “teams” had sufficient “playing time” in Indiana.  Regarding the second issue, the Pacers argued that both the Magic and Heat had nexus with Indiana based on their contacts with the state and thus could be included in the consolidated return as part of the Filing Group.  As noted above, Indiana statute permits an “affiliated group of corporations” to file a consolidated return, but each member must have income derived from Indiana.  See Ind. Code § 6-3-4-14(a) & (b).  The Commissioner noted that, if the Magic and Heat had no Indiana apportionment factors (property, payroll, and sales), neither would be considered to be doing business in Indiana pursuant to the Tax Court’s decision in Hunt Corp. v. Indiana Dep’t of State Revenue, 709 N.E.2d 766, 781 (Ind. Tax Ct. 1999).  For the sake of discussion, the Commissioner assumed that both the Magic and Heat had Indiana sales as separate teams.

The Pacers explained that the Magic’s president was also Pacers’ president, and the president visited Indiana twice monthly on average and conducted various managerial duties in Indiana.  And the Magic received management fees from the Pacers.  Citing Wabash, Inc. v. Indiana Dep’t of State Revenue, 729 N.E.2d 620 (Ind. Tax Ct. 2000), where the Tax Court found that the work by a subsidiary’s employee on behalf of the parent was sufficient to create nexus for the parent corporation, the Commissioner agreed that nexus would exist for the Magic if the president was performing work in Indiana on behalf of the Magic.  The Magic, however, reported no Indiana payroll or other Indiana apportionment factors.  Without evidence that the president was working in Indiana on behalf of the Magic (as opposed to the Pacers), the League Commissioner denied the protest with respect to the inclusion of the Magic on the 2007 consolidated return.

The Pacers further explained that the Heat’s employees attended quarterly training at the Pacers’ Indiana facility and that all purchases by the Heat from the Pacers were approved in Indiana.  Moreover, the Heat’s executives and employees traveled to Indiana monthly to address production and product ordering issues. And the Heat’s executives and employees engaged in quality review of products located in Indiana, according to the Pacers.  By rule, a corporation is considered to be doing business in Indiana, in part, if it accepts orders within the state or does “[a]ny other act . . . which exceeds the mere solicitation of orders so as to give the state nexus under P.L.86-272 to tax its net income.” (citing 45 IAC 3.1-1-38(6) & (7).)  The Commissioner discussed the U.S. Supreme Court’s decision in Wisconsin Dep’t of Revenue v. William Wrigley, Jr., Co., 505 U.S. 214, 232-33 (1992), noting the Court’s observation that certain ancillary activities related to solicitation and certain de minimis activities in a state did not cause a company to lose its immunity under P.L. 86-272.  But the Pacers’ shot fell short.  The League Commissioner concluded:

In this case, [the Pacers have] indicated that [the Heat] engaged in certain activities in Indiana. However, the activities in question are ancillary to the solicitation of orders.  As such, P.L. 86-272 precludes Indiana from subjecting [the Heat] to its corporate income tax, and thus [the Heat are] not considered to be ‘doing business in Indiana’ within the meaning of 45 IAC 3.1-1-38(7).

The Pacers lost this round of protests regarding the right to file a consolidated return, as the Magic and Heat effectively were ejected from Indiana for reporting purposes.  Today, however, the real Indiana Pacers take on the Miami Heat in the first game of the second round.  With luck (from the perspective of this fan!), the Pacers – having vanquished the Orlando Magic – will “consolidate” more wins and, by the end of this series, return the Heat home to Miami empty handed. 


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