Alert May 28, 2009

Policy Change Regarding Massachusetts Tax on Non-Filing Financial Institutions Having Economic Nexus with Massachusetts

In Technical Information Release 09-7 (“TIR 09-7”), the Massachusetts Department of Revenue (the “DOR” or the “Department”) announced another change in its non-filer “look-back” policy that  applies to a financial institution that has failed to file required Massachusetts tax returns. 

Background.  When a taxpayer fails to file a required tax return, the DOR may make an assessment of tax at any time for any taxable period for which a return was due.  The statute does not limit the number of past due returns or past tax periods for which the DOR may assess tax.  However, the DOR, in previously issued TIR 03-17, provided a general seven-year look-back rule and a special three-year look-back rule for certain taxpayers that voluntarily disclosed their failure to file, provided that there was a reasonable doubt that they had an obligation to file Massachusetts returns.

TIR 03-17 states as a general rule, subject to certain exceptions, that when the DOR determines that a taxpayer has failed to file required tax returns, the DOR will assess the taxpayer with respect to returns due during the most recent seven years.  However, to encourage voluntary compliance, TIR 03-17 also states that the Department, subject to certain exceptions, will limit assessments to the three most recent tax years in cases where certain non-filers voluntarily disclose their failure to file.  TIR 03-17 states that in cases in which a taxpayer seeks to apply the DOR’s three-year look-back policy, the DOR will nonetheless apply the seven-year policy, notwithstanding any voluntary disclosure, when an extensive level of business activity conducted in this state removes any reasonable doubt as to the taxpayer’s prior filing obligation.  Further, TIR 03-17 states that its discretionary policy is subject to exceptions based on consideration of particular facts and circumstances, in which cases the Department may require additional returns to be filed going back in excess of seven years.  In determining whether an exception applies, the DOR will consider whether the taxpayer has any basis for reasonable doubt about its obligation to file Massachusetts returns.

In Technical Information Release 08-4 (“TIR 08-4”), the DOR modified the TIR 03-17 rules for financial institutions that are presumed under the statute to be “engaged in business in the commonwealth” because of in-state lending and ancillary loan activity that exceeds specified amounts.  Instead of the three-year look-back period, the DOR would apply a five-year look-back period requiring tax filings for the tax years beginning with the tax year ending after January 1, 2003, if, by September 30, 2008, the taxpayer identified itself to the DOR as availing itself of the terms of TIR 08-4 and filed its returns and made full payment of the tax due and applicable interest and penalties by December 31, 2008.  Penalties generally were not waived under TIR 08-4 as they would have been if the general voluntary disclosure provision under TIR 03-17 applied.  (The TIR also applies to certain non-Massachusetts corporations that use their intangible property within Massachusetts to generate gross receipts within the state for the corporation, including through a license or franchise.)  In TIR 08-4, the DOR warned that it would not be bound by the seven-year look-back period provided in TIR 03-17 and “[would] apply a look-back period that is appropriate to the circumstances” to a financial institution within the scope of the TIR that did not voluntarily file returns under the provisions of the TIR.  The DOR was implicitly threatening, if an entity’s facts otherwise supported such an extended look-back period, to assess a financial institution for all tax years beginning on or after January 1, 1995.

Additional Changes in the Look-Back Policy.  The five-year look-back period in TIR 08-4 applied only to a taxpayer that, by September 30, 2008, identified itself to the DOR as availing itself of the terms of TIR 08-4 and filed its returns and made full payment of the tax due and applicable interest and penalties by December 31, 2008; therefore it is no longer available.  Until TIR 09-7 was issued, the DOR “[would] apply a look-back period that is appropriate to the circumstances.” In TIR 09-7, the DOR announces new look-back policies for financial institutions (and the same types of intangible holding corporations identified in TIR 08-4).  The new rules provide that the DOR will apply a look-back period in these cases that requires tax filings for all tax years beginning with the tax year ending on or after January 1, 2001, provided that the taxpayer identifies itself to the DOR, files its returns and makes full payment of the tax due, including any applicable interest and penalties, within a reasonable period of time that the Department may establish depending on the facts of each case. The provisions of the TIR only apply when the taxpayer’s filings are made in good faith in accordance with all applicable tax rules, including the pertinent corporate apportionment rules and all other applicable rules as stated in the Department’s public written statements.

In the case of any taxpayer that is within the scope of the TIR but does not voluntarily file under its terms, the DOR “will apply a look-back period that is appropriate to the circumstances and will not be bound by any previous publicly announced policy regarding look-back periods.”  Accordingly, the DOR is implicitly threatening, if the entity’s facts otherwise support such an extended look-back period, to assess a financial institution for all tax years beginning on or after January 1, 1995.  Although the DOR has authority to waive penalties for failure to timely file or pay a tax when a taxpayer demonstrates that the failure to file or pay resulted from reasonable cause and not willful neglect, it will generally not waive penalties in the cases to which TIR 09-7 applies.

Possible Action.  Even though the terms offered by TIR 09-7 are not attractive because of the relatively long look-back period and the failure to waive penalties, a taxpayer may choose to make voluntary disclosure because of the threat of an extended look-back period.  Moreover, under the new combined return rules applicable for tax years beginning on or after January 1, 2009, the DOR will be able to easily identify non-filing taxpayers that have an affiliate in a unitary business that files Massachusetts tax returns.