(a)
In
general. All that is necessary in order for the Commissioner to make
adjustments under section
12-226a
of the general statutes is an agreement, arrangement or understanding between
the company and another person that, whether by inadvertence or design, results
in an improper or inaccurate reflection of income. The Commissioner is not
required to establish improper accounting; fraudulent, colorable, or sham
transactions; or arrangements designed to reduce or avoid tax by shifting or
distorting income, deductions or capital. Nor is the Commissioner required to
establish that the agreement, arrangement or understanding is unlawful or not
legally binding upon the parties thereto. The Commissioner shall, however,
examine whether the terms of such agreements, arrangements or understandings
are consistent with the economic substance of the underlying transactions and
the actual conduct of the parties. Said section
12-226a
requires the Commissioner to adopt a regulation that sets forth standards for
taking the actions that are authorized under section
12-226a.
This regulation sets forth those standards.
(b)
Transactions at more or less than a
fair price with related persons.
(1)
Section
12-226a
of the general statutes authorizes the Commissioner to make adjustments where a
company has entered into a transaction with a related person at more or less
than a fair price which, but for such agreement, arrangement, or understanding,
might have been paid or received therefor, and there is a significant deviation
between the amount actually paid or received and the amount which, but for such
agreement, arrangement, or understanding, might have been paid or received. The
standard that the Commissioner adopts under this subsection of this regulation
is arm's-length consideration, as defined in subdivision (4) of subsection (g)
of this regulation. Adjustments made by the Commissioner under section
12-226a
to reflect arm's-length consideration have no effect on other Connecticut taxes
(e.g., sales and use taxes, real estate conveyance tax, etc.) where the amount
paid or received- not the amount which, but for such agreement, arrangement, or
understanding, might have been paid or received-is the measure of the
tax.
(2) The following
subparagraphs are by way of example and not of limitation.
(A) Transfers of tangible property. Where one
person sells or otherwise disposes of tangible property to a related person at
other than an arm's-length price, the Commissioner may make proper adjustments
to reflect arm's-length consideration for that property.
(B) Loans and advances. Where one person
makes a bona fide loan or advance directly or indirectly to, or otherwise
becomes a creditor of, a related person, and either charges no interest, or
charges interest at a rate which is not equal to an arm's-length rate of
interest with respect to the loan or advance, the Commissioner may make proper
adjustments to reflect an arm's-length rate of interest for that loan or
advance.
(C) Services. Where one
person performs marketing, managerial, administrative, technical, or other
services for the benefit of, or on behalf of, a related person either without
charge, or at a charge which is not equal to an arm's-length charge, the
Commissioner may make proper adjustments to reflect an arm's-length charge for
such services. However, a parent corporation providing supervisory services
(also known as stewardship or overseeing functions) to a subsidiary need not
charge the subsidiary for those services, which are regarded as providing the
parent corporation with a benefit relating to the conservation and protection
of its investment. (This is due to the fact that a parent corporation often
coordinates and oversees major policy decisions and sets strategic direction
for its subsidiaries.) A parent corporation is required to make an arm's-length
charge only for managerial services that would have provided the subsidiary
with a benefit had they been provided by a third party.
(D) Use of tangible property. Where
possession, use or occupancy of tangible property owned or leased by one person
is transferred by lease or other arrangement to a related person either without
charge or at a charge which is not equal to an arm's-length rental charge, the
Commissioner may make appropriate adjustments to reflect an arm's-length rental
charge.
(E) Transfer or use of
intangible property. Where intangible property or an interest therein is
transferred, sold, assigned, loaned or otherwise made available in any manner
by one person to a related person for other than arm's-length consideration for
such property or its use, the Commissioner may make appropriate adjustments to
reflect an arm's-length consideration for such property or its use.
(c)
Arrangements
with little or no business purpose.
(1) Section
12-226a
of the general statutes authorizes the Commissioner to disregard an arrangement
under which related companies may operate where one company so dominates and
controls the other that income of the companies is improperly or inaccurately
reflected, and it is neither realistic nor feasible to reconstruct the
transactions between them using the arm's-length consideration
standard.
(2) In determining
whether an arrangement under which related companies may operate results in the
improper or inaccurate reflection of the activity, business, income or capital
of the companies, the Commissioner shall consider whether (A) the companies are
motivated by business purposes other than tax avoidance or are principally
motivated by tax avoidance purposes; (B) the separate businesses of the
companies have economic substance because a reasonable possibility of obtaining
a profit exists, apart from achieving tax benefits; and (C) one company has a
significant amount of capital gains, interest, dividend, or similar income,
with only minimal capital, activity, or expenses, because essential corporate
functions are performed for the company by the other company without
arm's-length charges.
(3) In
determining whether related companies are motivated by business purposes other
than tax avoidance or are principally motivated by tax avoidance purposes and
whether the separate businesses of the companies have economic substance, the
Commissioner shall consider whether (A) the related person has an identifiable
place of business with supporting business records; (B) the related person
maintains books and related accounting records; (C) the related person has a
staff of employees or engaged contractors adequate in number and with
sufficient expertise to conduct its business affairs; (D) the company so
controls and dominates the finances, policy and business activities of the
related person that the related person has virtually no separate existence; (E)
the form employed for doing business is a sham; and (F) the separate businesses
have economic substance because a reasonable possibility of obtaining a profit
exists, apart from achieving tax benefits. No one factor is controlling in
determining whether the company and the related person are motivated by
business purposes and whether the arrangements have economic substance. An
arrangement between a foreign sales corporation, as defined in 26 U.S.C. §
922 and meeting the requirements of 26 U.S.C. §§
921 to
927, and its
shareholders shall not be considered an arrangement that is principally
motivated by tax avoidance purposes.
(4) The following examples illustrate the
application of this subsection.
Example 1: Company A carries on business in Connecticut and is
subject to corporation business tax. Company B, a wholly-owned subsidiary of
Company A, is a company that is exempt from the Delaware Corporation Income
Tax, under Del. Code Ann. tit. 30, §1902(b) (8), because its activities
within Delaware are confined to the maintenance and management of its
intangible investments. Company B leases an office for its exclusive use in
Delaware where it has a staff of employees adequate in number to conduct all of
its business affairs. All of Company B's assets are located in Delaware, and
all its business activities, including all day-to-day decision-making and
management functions, are conducted by its own officers and employees in
Delaware, who have appropriate authority and expertise commensurate with their
responsibilities. Company B received its intangible assets from Company A in a
transfer by Company A under
26 U.S.C. §
351 solely in exchange for stock in Company
B.
Based on these facts, the Commissioner shall determine that the
arrangement under which Company A and Company B operate does not result in the
improper or inaccurate reflection of the activity, business, income or capital
of the companies.
Example 2: Company G carries on business in Connecticut and is
subject to corporation business tax. Company H, a wholly-owned subsidiary of
Company G, is a company that is exempt from the Delaware Corporation Income
Tax, under Del. Code Ann. tit. 30, §1902(b) (8), because its activities
within Delaware are confined to the maintenance and management of its
intangible investments. Company H does not lease an office for its exclusive
use in Delaware and it does not have adequate staff to conduct its business
affairs. Not all of Company H's assets are located in Delaware, and some or all
its business activities, including all day-to-day decision-making and
management functions, are conducted by Company G in Connecticut. Company H
received its intangible assets from Company G in a transfer by Company G under
26 U.S.C. §
351 solely in exchange for stock in Company
H.
Based on these facts, the Commissioner shall determine that the
arrangement under which Company G and Company H operate results in the improper
or inaccurate reflection of the activity, business, income or capital of the
companies, because Company G controls and dominates the business activities of
Company H. Therefore, the Commissioner may shift income from Company H to
Company G, or expenses from Company G to Company H, to reflect income properly
or accurately.
(d)
Transfers for tax avoidance
purposes.
(1) Section
12-226a
of the general statutes authorizes the Commissioner to make adjustments to
items of income, deduction or capital in order to prevent the avoidance, in
whole or in part, of corporation business tax, where property is transferred
between a company and a related person in anticipation of a sale to an
unrelated person. The Commissioner shall weigh, as a factor in determining
whether a transfer was made to avoid, in whole or in part, corporation business
tax, the interval of time between the transfer by the company to the related
person and the sale to the unrelated person. This subsection may apply even if
arm's-length consideration is paid or received between the company and the
related person. However, this subsection shall not apply to any transfer to
which the provisions of subsection (c) of this regulation also apply.
(2) The following examples illustrate the
application of this subsection.
Example 1: Company J carries on business in Connecticut and is
subject to corporation business tax. Company K, a wholly-owned subsidiary of
Company J, does not carry on business in Connecticut. In anticipation of a sale
of certain of its property that is situated in Connecticut to an unrelated
person, Company J transfers the property to Company K, which then promptly
sells the property to the unrelated person for the sales price for which
Company J itself could have sold the property directly to the unrelated
person.
Based on these facts, the Commissioner shall determine that the
arrangement between Company J and Company K with respect to the property
results in the improper or inaccurate reflection of the net income of Company
J, and shall include in the net income of Company J the fair profits which, but
for such arrangement, Company J might have derived from the sale of the
property.
Example 2: The facts are the same as in Example 1, except that
Company K holds the property for a considerable length of time, making use of
it in the interim in its own business, before eventually reselling it to the
unrelated person.
Based on these facts, the Commissioner shall determine that the
arrangement between Company J and Company K with respect to the property does
not result in the improper or inaccurate reflection of the net income of
Company J (assuming that arm's-length consideration was paid by Company K on
the transfer of the property to it by Company J).
(e)
Nonrecognition provisions may not
bar adjustments. Section
12-226a
of the general statutes authorizes the Commissioner to disregard statutory
nonrecognition provisions when necessary to prevent the avoidance of taxes or
to reflect income properly or accurately.
(f)
Use of section
12-226a
by a company. A company has no right to apply section
12-226a
of the general statutes at will or to compel its application by the
Commissioner. However, section
12-226a
of the general statutes does not limit a company's ability properly or
accurately to reflect its activity, business, income or capital on its
corporation business tax return. Thus, if a company has conducted its activity
or business under any agreement, arrangement or understanding in such manner as
either directly or indirectly to benefit its members or stockholders, or any
other persons directly or indirectly interested in such activity or business,
by entering into any transaction at more or less than a fair price which, but
for such agreement, arrangement, or understanding, might have been paid or
received therefor, the company may report the results of any such transaction
based upon a price different from that actually paid or received if necessary
to reflect an arm's-length result. (If reported results differ from
transactional results recorded in the regular books and records of the company,
such difference must be accounted for in the same manner as such difference
would be accounted for federal income tax purposes.)
(g)
Definitions. For purposes of
this regulation, unless the context otherwise requires:
(1) "Person" means person, as defined in
section
12-1 of
the general statutes;
(2)
"Commissioner" means the Commissioner of Revenue Services;
(3) "Arm's-length consideration" is the
amount of consideration that would be paid or received (or the profits that
would have been earned) in a transaction between unrelated persons, where
neither person is under any compulsion to enter into the transaction and each
person has reasonable knowledge of all relevant facts.
(4) "Arms-length price" or "arms-length
charge" is the price or charge, respectively, that would be paid or received
(or the profits that would have been earned) in a transaction between unrelated
persons, where neither person is under any compulsion to enter into the
transaction and each person has reasonable knowledge of all relevant
facts.
(5) "Arms-length rental
charge" is the rental charge that would be paid or received (or the profits
that would have been earned) in a rental transaction between unrelated persons,
where neither person is under any compulsion to enter into the transaction and
each person has reasonable knowledge of all relevant facts.
(h)
Effective date.
This regulation shall apply to actions taken by the Commissioner on or after
the date of filing of this regulation with the Secretary of the
State.
