December 12, 1999 | By Keith Martin in Washington, DC

Alabama said that a local manufacturing company had to treat all of the dividends it received from two foreign subsidiaries as income from Alabama sources.

This meant the company had to pay income taxes on the dividends in Alabama. Most states require a company doing business in the state to allocate a share of its total income to the state based on the percentages of its total payroll, property and sales that are in the state.

In this case, QMS Inc. had its headquarters in Alabama. The company manufactured advanced printing systems. It had two wholly-owned foreign subsidiaries that did not do any business in Alabama, but the state said the subsidiaries were “integrally related” to the parent company. The parent pledged the shares of the subsidiaries as collateral for a loan. This triggered a “deemed” dividend under section 956 of the US tax code: the parent company was treated as having had the use of undistributed earnings in the foreign subsidiaries because it effectively borrowed against them in the United States.

The Alabama Department of Revenue said that the entire deemed dividend should be allocated to Alabama for state tax purposes. The decision was upheld this fall on appeal to an administrative law judge.