Pepsi Tax Case Reveals Why 80/20 Exclusion Is a Unhealthy Thought for States

Pepsi Tax Case Reveals Why 80/20 Exclusion Is a Unhealthy Thought for States


PepsiCo Inc. v. Illinois Dept. of Income shines a light-weight on an obscure state tax provision that facilitates revenue shifting by multi-jurisdictional taxpayers: the exclusion of so-called 80/20 corporations from the “water’s edge” mixed submitting necessities of some 15 states. The eye is lengthy overdue.

An 80/20 firm is a home company, absolutely topic to federal tax, with not less than 80% of its property and payroll positioned abroad. Not all 80/20 statutes are the identical—some reference a since-repealed federal definition of an lively international enterprise in former Part 861(c)(1) of the tax code, whereas others deal with the gross sales issue as properly. The distinctions are comparatively minor in sensible impact.

The 80/20 exclusion traces its roots to the 1984 Worldwide Unitary Taxation Working Group, convened within the aftermath of the US Supreme Courtroom’s resolution upholding California’s worldwide mixed reporting system. Confronted with threats of federal preemption of unitary mixed reporting necessities, states agreed to discontinue obligatory worldwide mixed reporting with the promise of elevated federal enforcement of switch pricing guidelines.

One in every of solely two areas of disagreement within the last report was the proposed exclusion of home 80/20 corporations from the water’s edge return, as state representatives acknowledged the potential for abuse. Regardless of these objections, the 80/20 exclusion grew to become part of many—although not all—states’ water’s edge reporting programs within the Eighties.

Understanding how 80/20 corporations can be utilized to shelter earnings requires an evidence of two key facets of state company taxation.

First, most states’ definition of 80/20 corporations depend on the slim definitions of “property” and “payroll” borrowed from the Uniform Division of Revenue for Tax Functions Act. The UDITPA was meant to supply simply administered uniform guidelines for apportioning the incomes of producing and mercantile corporations. It by no means aimed to handle the tax-motivated company buildings and transactions seen right this moment.

The UDITPA’s measure of property is restricted to actual and tangible property, whereas the payroll issue is restricted to W-2 workers. These bare-boned definitions permit for the creation of a non-combinable, non-taxed 80/20 firm just by finding a minimal quantity of bodily property abroad, whereas transferring the payroll duties for a number of workers already abroad to the brand new entity.

The second key level is the affect of states’ conformity to the federal tax code. The tax code’s earnings calculations are designed to perform within the context of the federal consolidated submitting system, comparable in scope to the states’ water’s edge reporting, however for the 80/20 exclusion. Part 351 of the tax code performs a essential position in state tax minimization plans, because it permits home companies to switch tangible and intangible property to a newly created home subsidiary with out tax recognition.

Such transfers are permitted below the federal tax code as a result of the brand new entity will likely be topic to federal tax—and can nearly actually file on a consolidated foundation with the transferor. In contrast, had that very same switch of property been made to a international subsidiary, it could have subjected the US guardian company to a tax below Part 367(d), to forestall the lack of income attributable to the transferred property.

With these factors in thoughts, the image of how the 80/20 exclusion permits corporations to cut back state tax income turns into clearer. The UDITPA’s definitions lack the subtlety and nuance required to handle tax-motivated buildings and transactions equivalent to “loaned” workers.

In the meantime, the states’ departure from the federal consolidated taxing system offers the means to shift earnings away from the water’s edge reporting group by permitting for untaxed transfers of income-generating intangible property to the 80/20 firm.

The transfers are afforded non-recognition therapy though the recipient is exterior the states’ taxing jurisdiction. But as a result of the recipient isn’t actually international, the transferring entity isn’t topic to a corresponding tax legal responsibility.

4 many years after 80/20 corporations entered the state tax lexicon, they continue to be a treatment in the hunt for an issue. Though 80/20 corporations typically are known as international working corporations, it’s an intentional misnomer. These aren’t precise international corporations, and so they aren’t required to meaningfully interact in international commerce, so issues over worldwide taxing conventions are misplaced. So too are recommendations that their international nature makes accounting harder.

It’s unclear if the eye the PepsiCo case brings to the 80/20 exclusion will end in constructive legislative modifications.

In 2013, the Minnesota legislature eradicated its 80/20 provision in response to a state supreme courtroom resolution holding that the Division of Income was powerless to handle revenue shifting to a one-person 80/20 firm, nominally positioned within the Cayman Islands. The Vermont legislature eradicated its 80/20 loophole in 2022.

However the Colorado legislature didn’t act in 2017 after a district courtroom in that state detailed how Goal Corp. shielded $18 billion in earnings from the state’s mixed report by making royalty funds to its five-person 80/20 firm in Hong Kong.

The mechanisms for earnings shifting outlined above equally apply to separate-entity submitting programs. Though the states have responded in varied methods, together with challenges utilizing comparable income evaluation, the authorized buildings that facilitate earnings shifting stay in place.

The very best response could be to undertake a complete mixed submitting statute together with all unitary companies within the mixed group. The Multistate Tax Fee has developed two such fashions for states’ consideration.

The case is PepsiCo Inc. v. Illinois Dept. of Income, In poor health. Cir. Ct., No. 2022TX000155.

This text doesn’t essentially mirror the opinion of Bloomberg Business Group, Inc., the writer of Bloomberg Legislation and Bloomberg Tax, or its homeowners.

Creator Info

Bruce Fort is senior counsel on the Multistate Tax Fee. The views expressed herein are these of the creator and don’t essentially symbolize the views of the Multistate Tax Fee or its members.

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