Michigan Provides Guidance on the Unitary Business Group

Determining whether related entities constitute a unitary business group that is required to file a combined return is complicated, but a recent Michigan advisory helped to shed some light on the matter.

By Jess Johannesen, SALT Manager

On May 23, 2018, the Michigan Department of Treasury released a Revenue Administration Bulletin (“RAB”) that describes the control test and two of the alternative relationship tests used to determine whether certain entities constitute a unitary business group. [1] For purposes of Michigan’s Corporate Income Tax, members of a unitary business group must file a combined return.[2]

Michigan defines a unitary business group as a group of U.S. persons (1) where one member owns or controls, directly or indirectly, more than 50 percent of the voting rights of the other members and (2) that has activities which result in a flow of value among the members or has activities that are integrated with, dependent upon, or contribute to each other.[3]  States with unitary business group concepts typically contain some version of the (1) control test and (2) relationship test.  In Aprio’s April 2017 SALT Newsletter, we discussed a Michigan Court of Appeals case that impacted how indirect ownership is treated within the control test.  You can refer to our April 2017 article for additional information regarding the control test.  This article focuses on the relationship tests.

To constitute a unitary business group, Michigan requires that one of two alternative relationship tests be met in addition to the control test.[4]  These relationship tests are often factual determinations considered on a case-by-case basis by states, and Michigan describes these alternative tests in its recently released RAB.  The first alternative test is the Flow of Value Test, and Michigan refers to the U.S. Supreme Court description that no one fact determines whether a flow of value exists but rather the totality of facts and circumstances surrounding the business activities and operations should be weighed and examined for their cumulative effect.  Specifically, Michigan’s Flow of Value Test looks to three factors: (A) functional integration, (B) centralized management and (C) economies of scale.

Functional integration refers to the business activities that significantly affect the operations of the group members.  Functional integration can be either horizontal integration or vertical integration.  Horizonal integration is characterized by entities that engage in similar business activities or processes, while vertical integration is evidenced by entities that each engage in a different step of a structurally coordinated enterprise.  Examples of factors that may point to the existence of functional integration are: intercompany sales, exchanges, or transfers of intangibles, services, or products between entities; transfers of technical information or other intangibles that are significant to the operations or activities of the entities; the sharing and use of any administration, accounting, payroll, inventory control or distribution systems controlled through a common network; common marketing that results in mutual advantage; and common intercompany financing.

Centralized management refers to the involvement and oversight by management in the operational decisions of the entities.  The decentralization of day-to-day management responsibility does not preclude the existence of centralized management if an integrated executive force has control over major policy decisions.  Indicators of centralized management include: business “guidelines” established by a parent for its subsidiaries, the “consensus” by which a parent’s management process was involved in the subsidiaries’ business decisions, or the oversight and other assistance provided by one entity to the other.

Economies of scale refers to 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, such as the use of centralized purchasing to obtain volume discounts.  Economies of scale may result from either functional integration or centralized management.  For example, the decision to pool advertising may indicate functional integration and may also indicate that a centralized management decision was made that results in economies of scale.  There is no clear delineation between the three factors, and one factor may evidence the existence of other factors.

Michigan’s second alternative relationship test is the Contribution/Dependency Test.  This test asks whether business activities are integrated with, are dependent upon, or contribute to each other.  The focus is on whether one entity’s business activities depend upon the business activities of another entity, or whether the activities of one entity contributes to the activities or operations of another entity.  This may occur under many of the same circumstances as the Flow of Value Test, such as intercompany financing or sales, or through executive policymaking, personnel training, research and other functions.

One final point worth noting is that the existence of a unitary business group does not require that each entity meet the relationship test with each member of the group, rather that each entity meet the test with at least one other member of the group.  While this guidance is specific to Michigan, it is helpful generally since most states with unitary business/combined reporting concepts look to similar factors.

Aprio’s SALT group has experience in navigating the complex state income tax combined filing/unitary business rules and can advise on the appropriate filing methodology to meet each state’s requirements and/or minimize state income tax liabilities.  We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Jess Johannesen, SALT manager, at jess.johannesen@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the July 2018 SALT Newsletter.

[1] Michigan Revenue Administration Bulletin 2018-12, 05/23/2018.

[2] MI Comp. Laws Ann. §206.691(1).

[3] MI Comp. Laws Ann. §206.611(6).

[4] Technically, Michigan provides that affiliated groups meeting the control test can elect to be treated as a unitary business group.  In such elective situations, the relationship test need not be satisfied.

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.