The Minnesota Supreme Court held that the income of a foreign entity owned by a C Corporation is included in the corporation’s income when the entity is treated as a disregarded entity for federal income tax purposes. The taxpayer, a C corporation that did business in Minnesota, was liable for Minnesota corporate income tax. The taxpayer acquired a subsidiary that owned 100% of a foreign entity. The foreign entity was treated as a disregarded entity for federal income tax purposes. When preparing its Minnesota combined income tax return, the taxpayer included the subsidiary’s income, which included the income of the disregarded entity.
After an audit of the taxpayer, the tax commissioner concluded that the income, losses, and deductions of the foreign disregarded entity should not be included in the calculation of the taxpayer-subsidiary unitary business income. The commissioner argued that the entity’s federal election could not be recognized under the Minnesota’s water’s edge rule. In addition, the commissioner claimed, even if the entity was disregarded under Minnesota law, the entity’s foreign nationality required its income and losses to be excluded under the water’s edge rule. However, the court ruled that including the income of a foreign disregarded entity in “net income” does not violate the water’s edge rule because the entity does not retain a nationality separate from its owner under Minnesota tax law.
The court notes that its conclusion runs contrary to Revenue Notice 98-08. In that notice, the Department of Revenue stated it would not recognize elections made by foreign entities with a single C corporation owner to be disregarded as separate entities from their owners. However, as the court states, revenue notices do not have the force and effect of law, and Minnesota law requires that “any election” made by a taxpayer be recognized.
Ashland Inc. and Affiliates v. Commissioner of Revenue, Minnesota Supreme Court, No. A16-1257, August 2, 2017, ¶204-280