A bank holding company and its affiliates, a unitary group that included a real estate investment trust (REIT), were allowed to defer the recognition of divided income received by one of the members, “deferred holdings,” from the REIT for Indiana financial institutions tax purposes. In addition, subject to verification by audit that the taxpayer did not eliminate intercompany receipts in its apportionment calculations, the taxpayer was not required to add back dividends paid by a captive REIT for financial institutions tax purposes.
On December 31, 2001, the REIT issued dividends to deferred holdings and took the dividends paid deduction in 2001. Deferred holdings filed its return on a 52-53-week year, which is permitted under federal IRC §441, that ended on December 26, 2001, so did not recognize the income until 2002. Federal anti-abuse provisions for certain passthrough entities prevent substantial deferral and distortion of income reporting by providing that if a corporation and a passthrough entity have years that end in the same month or by reference to the same month, income is reallocated to the reference month. In mid-2002, the federal regulations were changed to include certain REITs in the definition of passthrough entity to prevent taxpayers from being able to manipulate income from year to year.
The Indiana Department of Revenue reallocated the dividend income from 2002 to 2001, citing IC §6-5.5-5-1(b), which provides that if the department determines that the result of applying this section does not fairly represent the taxpayer’s income within Indiana or the taxpayer’s income within Indiana may be more fairly represented by a separate return, the department may require (1) separate accounting; (2) the filing of a separate return for the taxpayer; and/or (3) a reallocation of tax items between a taxpayer and a member of the taxpayer’s unitary group. Although the income deferral had the effect of not fairly representing the taxpayer’s Indiana income for 2001 and 2002, a plain reading of the statute does not present the option of reallocating a single entity’s income from one year to another. Therefore, the deferred recognition of the dividend income was allowed.
After December 31, 2001, IC § 6-5.5-1-18 provides that only entities transacting business in Indiana are to be included in a combined return. Prior to this, all members of a unitary group were to be included in the combined return.
Although the REIT did business in Indiana, the owner of the majority of the shares in the REIT, the recipient, fell outside the unitary group because it was not itself doing business in Indiana. The department disallowed the REIT’s dividends paid deduction to affiliated controlled entities that were not included in the Indiana combined return, claiming that the taxpayer’s income was not fairly represented.
The taxpayer, however, pointed out that legislation that would require a REIT to add back this “escaped” dividend income for purposes of the financial institutions tax was introduced but not enacted in 2009. S.B. 541 would have established the same captive REIT addback for the financial institutions tax that exists for the corporate adjusted gross income tax. The fiscal impact statement specified that a REIT could avoid corporate adjusted gross income tax by claiming the dividends paid deduction and passing the income through to the shareholders of the REIT, which could be an affiliate of the financial institution in another state not subject to Indiana tax. Consequently, the REIT’s dividend paid deduction was sustained subject to verification by audit that the taxpayer did not eliminate intercompany receipts in its apportionment calculations.