Alaska Supreme Court Holds Combined Group Must Include Portion Of Foreign Dividends In Income Tax Base

The Alaska Supreme Court has determined that a unitary group was required to include 20 percent of foreign dividends in its combined corporation net income tax return.1 Under the Alaska net income tax, corporations must include 20 percent of dividend income received from foreign corporations. However, Internal Revenue Code (IRC) Section 882 requires a foreign corporation to report only income effectively connected with the conduct of business within the United States. Because the federal provision was inconsistent with Alaska law and not adopted by reference, Alaska law controlled and the taxpayer was required to include a portion of the foreign dividends.

Background

Schlumberger Limited ("Limited"), a multinational company incorporated in the Netherlands Antilles, engaged in services limited to the management of its subsidiaries. In addition to the fees it received for this service, Limited received dividends from its subsidiaries around the world. In Alaska, Limited operated through a wholly-owned subsidiary, Schlumberger Technology Corporation ("Technology"), which owned and operated all of Limited's associated domestic companies. Technology filed a consolidated federal tax return for all of these subsidiaries. For Technology's 1998-2000 tax years, Technology filed Alaska corporate income tax returns that included only the domestic subsidiaries in the oilfield services industry, its primary line of business.

As a result of an audit, the Alaska Department of Revenue found that Limited was engaged in a unitary business with Technology for purposes of the Alaska combined reporting statute that requires members of affiliated groups to include in their income tax returns corporations whose "property, payroll, and sales factors in the United States average 20 percent or more."2 The auditor thus concluded that Limited was a "water's edge" affiliate of Technology within the meaning of the statute. Based on these determinations, the Department assessed additional corporate income tax.

After an informal conference decision affirmed that Technology must include 20 percent of Limited's foreign dividend income in the group's apportionable income, Technology appealed to the Alaska Office of Administrative Hearings. The administrative law judge denied Technology's motion for partial summary judgment on whether Technology could be assessed based on amounts received by a related foreign corporation that were earned outside the United States. According to the judge, Alaska's change to water's edge accounting limited the types of corporations included in the unitary group for purposes of determining apportionable income but did not limit the types of income to be apportioned from the members. Accordingly, the judge concluded that Alaska's apportionment methodology should be applied to determine Technology's taxable income, declining to apply a federal provision, IRC Section 882, which excludes...