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Questions About Taxes And Auditing
Fill in the blanks with your answers to the questions listed below. Please give citations to the right authorities.
A. Please defend Alixco’s view on non-unitary tax filing.
B. How should each company’s items of income be classified as business or non-business income? Please construct your response as if the auditor’s audit report was prepared in accordance with MTC requirements.
C. Explain how Alixco’s sales to California would be apportioned on the joint Missouri tax return and the combined California corporation tax return (assuming California applies the “Finnigan” rule). Why?
Smith’s Home Hardware is a profitable retail enterprise situated in Arizona that makes considerable earnings from its retail hardware stores. Smith’s contributes $70 million to the formation of a subsidiary (“Alixco”). The capital investment comprises $15 million in goods, $15 million in CDs, a $10 million office building in Missouri, and $30 million in patents on high-tech power equipment. Alixco’s headquarters are located entirely in Missouri. The construction industry will be served by Alixco, which will manufacture and distribute power tools. Alixco earns $100 million in tool sales in 2001, $50,000 in interest on commercial CDs, $1.5 million in rent from 9 floors of its 10-story office building, and $3 million in royalties from international licensing of its tool patents. For the year, business deductions totaled $85 million.
In Missouri, Alixco hires a president. The remainder of the Board of Directors and Officers is made up of Smith’s Home Hardware officers. The records are kept by Smith’s own accounting staff in Arizona. Annual financial statements are prepared by a Missouri CPA firm. Alixco’s only assets are the ones listed above, as well as a recently built manufacturing factory in New Mexico and another newly built plant across the border in Mexico.
The CDs were purchased for $15 million and the office building was purchased for $10 million with proceeds from retail hardware store operations. Alixco and Smith’s Home Hardware file a joint federal tax return. Alixco submits a California tax return, while Smith’s Home Hardware does not. Alixco paid Smith’s Home Hardware $2 million in dividends in 2001, which were utilized to expand existing retail locations. There are no intercompany sales other than the original inventory contribution. Smith’s purchasing agents, on the other hand, handle about 20% of Alixco’s purchases.
Smith’s Home Hardware had a $40 million profit in 2001, with 75 percent of it going to Arizona and 25 percent to California. For the year 2001, Smith’s filed a separate return in California. Smith’s Home Hardware was audited by the California Franchise Tax Board, which determined that Smith’s and Alixco should be part of a unitary group submitting an unified California tax return. The Alixco net business income was included to the joint return by the auditor, resulting in a $300,000 tax increase in California.