Michigan Tax Tribunal holds subsidiary not a member of owner’s unitary business

In brief

For tax years 2013-2016, TTI, Inc. (TTI) asserted that its wholly owned subsidiary, Mouser Electronics (Mouser), was not a member of its Michigan Corporate Income Tax Unitary Business Group (UBG).

The Michigan Tax Tribunal (Tribunal) recently agreed the entities were not part of the same UBG, finding that TTI and Mouser did not have business activities or operations resulting in a flow of value between them or business activities or operations that are integrated with, are dependent upon, or contribute to each other.

The takeaway: Although unitary business determinations are highly fact specific, the TTI decision provides helpful background for taxpayers looking to analyze their unitary relationship with affiliates. In contrast to the Michigan Treasury Department’s broad view regarding satisfaction of the relationship component of the unitary analysis, and its historical reliance on the unitary questionnaire in making unitary determinations, the Tribunal in this case employed a much more nuanced and detailed approach to an analysis that has a direct impact on the tax calculation.

[TTI, Inc. vs. Michigan Department of Treasury, Mich. Tax. Trib., No. 21-002481 (10/17/23)]

Department’s administrative guidance

The Tribunal recognized the “respectful consideration” given to Department administrative guidance provided in Revenue Administrative Bulletin (RAB) 2018-12, which details two alternate tests to establish a UBG:

• Flow-of-value test. Related companies have business activities or operations that result in a flow of value between or among the potential members, or
• Contribution/dependence test. The companies have business activities or operations that are integrated with, are dependent upon, or contribute to each other.

Flow of value test held not satisfied

The RAB identifies three elements of the flow-of-value test: functional integration, centralized management, and economies of scale. The Tribunal held that none of the three elements were satisfied in this case.

No functional integration

The RAB provides that the flow-of-value test states that a unitary business is a “functionally integrated enterprise whose parts are mutually interdependent such that there is a flow of value between them.”

TTI argued that it was not functionally integrated with Mouser because Mouser maintained autonomy over its general business strategy, operations, personnel, accounting, and financing. TTI asserted that:

“[TTI] provides components to large volume production users while Mouser sells its components in small quantities to product developers and engineers. Further, the two companies operate separate sales, distribution, and warehousing operations and locations. In doing so, the two companies utilized separate supply chain, accounting, human resources, and IT operations without sharing common employees or tangible personal property.”

The Department argued that functional integration existed due to intercompany sales and common marketing.

Intercompany sales

The Tribunal disagreed that the intercompany sales supported functional integration, arguing that the sales did not rise to a level of required significance. The purchases made up a fraction of each organization’s total sales, transactions were only initiated if the companies could not get parts from distributors, and request for parts were subject to approval that may result in missing out in distributor discounts and other benefits. The Tribunal concluded that such details supported the inference that intercompany sales were “not an advantage.”

Common marketing

The Tribunal found that marketing materials describing TTI and Mouser as part of the same “family of companies” did not give either company an actual advantage given the companies’ separate pricing. Further, customers did not receive any “advantage, discount, or benefit from the companies’ relationship.” Finally, the Tribunal determined that mentioning and describing each other on a website “hardly rises to the level of common marketing that would result in significant cost savings, significant improvement of income, or mutual advantage.”

No functional integration

The Tribunal found no functional integration between the two companies. Transfer of products between the companies did not significantly affect the operations of the entities. Transfers did not generate income and as a matter of policy were only done as a last resort when products were not otherwise available. The companies had separate purchasing, operations, and distribution systems. There also was no evidence of other shared intangibles such as patents, trademarks, service marks, copyrights, trade secrets, knowhow, formulas, or processes.

No centralized management

The Tribunal concluded that centralized management did not exist for several reasons, including that dozens of critical business functions were duplicated (e.g., human resources, and accounting).

No economies of scale

The RAB noted that an element of the flow-of-value test involves whether economies of scale exist. The RAB interprets “economies of scale” as “a relationship between business activities that results in a significant decrease in the cost of operations or administrative functions for the entities due to an increase in operational size.”

TTI asserted that there was “clear evidence that these companies choose to duplicate costs rather than to consolidate their business operations to generate economies of scale.” The Tribunal found insufficient evidence of economies of scale, observing that dozens of critical business functions were duplicated and, therefore, “the two companies are nearly devoid of economy of scale. The companies’ operations and a few shared benefits do not rise to the level of ‘significant decrease in the costs of operation or administrative functions’ described by the RAB guidance.”