Earlier this month, the New Mexico Administrative Hearings Office issued an opinion that addressed the questions on the minds of many state tax professionals in the wake of federal tax reform: under what circumstances can a state constitutionally impose tax on a domestic company’s income from foreign subsidiaries, including Subpart F income, and when is factor representation required? These issues have recently received renewed attention in the state tax world due to the new federal laws providing additions to income for foreign earnings deemed repatriated under Internal Revenue Code (IRC) section 965 and for global intangible low-taxed income (GILTI). Since many state income taxes are based on federal taxable income, inclusion of these new categories of income at the federal level can potentially result in inclusion of this same income at the state level, triggering significant constitutional issues.

In Matter of General Electric Company & Subsidiaries, a New Mexico Hearing Officer determined that the inclusion of dividends and Subpart F income from foreign subsidiaries in General Electric’s state tax base did not violate the Foreign Commerce Clause, even though dividends from domestic affiliates were excluded from the state tax base, because General Electric filed on a consolidated group basis with its domestic affiliates.

The Hearing Officer distinguished the facts in General Electric from the facts of a 1997 New Mexico Supreme Court case, Conoco Inc. v. New Mexico Taxation and Revenue Department, 1997-NMSC-005 (NM Sup. Ct. 1997), in which the court determined that the inclusion of dividends from foreign corporations in the state tax base of a taxpayer that filed its New Mexico returns on a separate entity basis is unconstitutional, even if the factors of the foreign corporations are represented in the taxpayer’s apportionment formula. The Hearing Officer determined that a different result was required for a taxpayer that reports its income on a consolidated basis with its domestic affiliates because, unlike with a separate entity filer, the earnings of the domestic affiliates are included in the state tax base through the consolidated filing, even if domestic dividends are ultimately deducted. The Hearing Officer, relying on holdings of other state courts, reasoned that inclusion in the tax base of the dividends and Subpart F income from foreign corporations is permissible when the taxpayer files a consolidated New Mexico return because, while foreign income and domestic income may not be taxed in the exact same manner, “there is a tax symmetry” under the consolidated group method that renders the state’s taxation of foreign dividends constitutional.

Another important issue that arises with respect to the inclusion of dividends and Subpart F income received from foreign corporations is whether the factors, or a portion of the factors, of the foreign corporations need to be included in the taxpayer’s apportionment formula. In this case, such issue did not need to be addressed because the Department had computed the taxpayer’s proposed tax liability by including the foreign corporations’ factors in General Electric’s New Mexico apportionment factor. Noting the importance of this issue, however, the Hearing Officer did state that “[f]ormula factor relief, is certainly relevant to the question of disparate treatment between foreign and domestic dividends, even if it by itself it’s not dispositive of the question.”

As the issue concerning inclusion of traditional Subpart F income in the state tax base has constitutional implications, so does the issue concerning inclusion of deemed repatriated foreign earnings and GILTI. Thus, taxpayers should consider these issues as they assess the state tax implications resulting from federal tax reform.