Disclaimer Ernst amp Young refers to the global organization of member firms of Ernst amp Young global limited each of which is a separate legal entity Ernst amp Young LLP is a clientserving member firm of Ernst amp Young global limited located in the US ID: 677470
Download Presentation The PPT/PDF document "Apportionment of corporate income betwe..." is the property of its rightful owner. Permission is granted to download and print the materials on this web site for personal, non-commercial use only, and to display it on your personal computer provided you do not modify the materials and that you retain all copyright notices contained in the materials. By downloading content from our website, you accept the terms of this agreement.
Slide1
Apportionment of corporate income between the states for items of income other than tangible personal propertySlide2
DisclaimerErnst & Young refers to the global organization of member firms of Ernst & Young global limited, each of which is a separate legal entity.
Ernst & Young LLP is a client–serving member firm of Ernst & Young global limited located in the US
.
NMTRD refers to the New Mexico Department of Taxation and Revenue.
AZDOR
refers to the Arizona Department of Revenue.
Ernst & Young and its member firms, NMTRD and AZDOR expressly disclaim any liability in connection with use of this presentation or its contents by any third
party. These
slides are for educational purposes only and are not intended, and should not be relied upon, as accounting or legal advice
. The
views expressed by panelists in this webcast are not necessarily
those
of Ernst & Young
or its member firms,
NMTRD or AZDOR.Slide3
Your Presenters
Helen Armstrong
Brad Odell
Carl Joseph
Steve Shiffrin
If you need CPE/CLE don’t forget to sign the sheetSlide4
Uniform Division of Income for State Purposes Act (UDITPA)
General DescriptionSlide5
Basis for Apportionment and Allocation of Income
Complete Auto Transit, Inc. v. Brady
,
430 U.S. 274 (1977) – Provided test for determining if state tax violates commerce clause
there is substantial nexus between the state and the activity being taxed;
The tax is fairly apportioned;
The tax does not discriminate against interstate commerce; and
The tax is fairly related to the services provided by the state.Slide6
Defining Allocation and Apportionment
Allocation refers to the method of dividing a tax base by tracing particular property, receipts, or income to their source or other connection with a state, and attributing the item in its entirety to that state.
Hellerstein
, State Taxation
¶ 8.04
Apportionment uses selected factors for attributing the tax base to a particular state or states based on the taxpayer using its property, carrying on its activities, and earning income in that state or states.
Hellerstein
, State Taxation
¶ 8.05Slide7
Uniform Division of Income for Tax Purposes Act
UDITPA § 2 – taxpayer having income from business activity which is taxable both within and without the state … shall allocate and apportion its net income
UDITPA § 3 – test to determine if taxpayer is taxable in another state
taxpayer actually subject to a tax in another state
state has jurisdiction to subject the taxpayer to a tax regardless if it does or does notSlide8
Business v. Non-business Income under UDITPA § 1(A) & (E)
Business Income
– Income arising from transactions and activity in the regular course of the taxpayer’s trade or business and income from the disposition or liquidation of a business or segment of a business. Business income includes income from tangible and intangible property if the acquisition, management, or disposition of the property constitutes integral parts of the taxpayer’s regular trade or business operations
Non-business income
– everything elseSlide9
Allocation of Non-business Income – UDITPA §§ 4-8
Allocable Income is non-business income
Statutory and Regulatory Rules governing allocable income:
Net rents and royalties from real property
Net rents and royalties from tangible personal property
Capital gains and losses
Interest and Dividends
Patents and copyright royaltiesSlide10
Apportionment of Business Income – UDITPA §§ 9-17
All business income is apportioned to the states typically using a three factor formula
Property, payroll, and sales
Income is multiplied by a fraction consisting of the property factor plus the payroll factor plus the sales factor divided by 3
Many states are modifying their apportionment factors
New Mexico – single sales factors for manufacturers (phased in over time) and business headquarters
operations
Arizona – single sales factor phased in by tax year 2017
Other statesSlide11
Sales Factor – UDITPA §§ 15-17Calculation of sales factor
Numerator is total sales of the taxpayer in the state
Denominator is total sales of the taxpayer everywhere during the tax period
Determination of sales within the state depends on whether the sale relates to tangible personal property or everything elseSlide12
Determination of sales, other than sales of tangible personal property – UDITPA § 17
Sales, other than sales of tangible personal property, are in this state if:
The income producing activity is performed in this state; or
The income producing activity is performed both in and outside this state and a greater portion of the income-producing activity is performed in this state than in any other state, based on costs of performance.Slide13
Apportioning the Sale of Services
Defining first what is the income producing activity.
The transactions and activity engaged in by the taxpayer in the regular course of its trade or business for the ultimate purpose of producing that item of income. MTC Reg. IV. 17(2); NMAC 3.5.18.8(a
); A.A.C. R15-2D-806(1).Slide14
Apportioning the Sale of Services
Cost of performance
Definition: direct costs determined in a manner consistent with generally accepted accounting principles and in accordance with conditions or practices in the trade or business of the taxpayer. MTC Reg. IV. 17(3); NMAC
3.5.18.8; A.A.C R15-2D-806(1).
Determination
Costs between taxing state and the costs in any other individual state (not aggregated) –
Clipper Express Co. v.
Comm’r
of Revenue
, No. 120514, 1986 WL 22656, at *4 (Mass. App. Tax Bd. Nov. 14, 1986)Slide15
Apportioning the Sale of Services
Market-State Approach
Attributing the receipts from services according to the taxpayer’s market
Customer location v. benefit of the service
Revised Section 17 of UDITPA
In 2014, the MTC adopted a revised section 17 of UDITPA to provide that receipts, other than receipts for the sale of tangible personal property, be sourced based on marketSlide16
MTC Article IV, § 17
Sales
, other than sales of tangible personal property, are in this State if:
(a) the income-producing activity is performed in this State; or
(b) the income-producing activity is performed both in and outside this State and a greater proportion of the income-producing activity is performed in this State than in any other State, based on costs of performance.
Arizona’s version: A.R.S. § 43-1147Slide17
MTC Reg. IV.17(2)
Sales
Factor: Sales Other Than Sales of Tangible
Personal Property
in This
State
(2)Income producing activity: defined.
The term "income producing
activity“ applies
to each separate item of income and means the transactions and activity
engaged in
by the taxpayer in the regular course of its trade or business for the ultimate purpose
of producing
that item of income.
Such activity includes transactions and
activities performed
on behalf of a taxpayer, such as those conducted on its behalf by
an independent
contractor
.
Source: MTC, emphasis added, as revised through 7/29/2010.Slide18
A.A.C. R15-2D-806(1)(d)
The term “income-producing activity” applies to
each separate
item of income and means the transactions
and activities
directly engaged in by a taxpayer in the
regular course
of its trade or business for the ultimate purpose
of obtaining
gains or profit.
Income-producing activity
does not
include transactions and activities performed
on behalf
of a taxpayer, such as those conducted on its
behalf by
an independent contractor.
Accordingly, “
income producing activity
” includes but is not limited to
the following: (d) The
sale, licensing, or other use of
intangible personal
property. The mere holding of
intangible personal
property is not, of itself, an
income producing activity.
Emphasis added.Slide19
Walter E. Heller Western, Inc. v. Arizona Dept. of
Revenue
1
Heller Western was
engaged in commercial
financing.
It was headquartered out-of-state but had a branch in Arizona that solicited new customers, checked credit, negotiated and serviced contracts.
Its
headquarters issued commercial paper to obtain cash to fund the lending process.
1
161 Ariz. 49
,
775 P.2d 1113 (1989)Slide20
Heller Western
With respect to IPA, the Arizona Supreme Court held that:
IPA
included
solicitation
,
investigation, negotiation
and
servicing of Arizona customers and contracts.
IPA
did not include
costs associated with borrowing of money by out-of-state headquarters to make loans to instate customers.
General focus on location of consumer was preserved.Slide21
M.D.C. Holdings, Inc. v. State
ex rel. Ariz.
Dept.
of
Revenue
MDC engaged in home building and
financing.
MDC earned
income from
(among other things), secondary
marketing
of the loans.
MDC argued that the IPA and COP for the secondary marketing took place in Colorado.
AZDOR argued that the secondary marketing was part of the entire transaction.
1
222 Ariz. 462, 216 P.3d 1208, (App. 2009)Slide22
M.D.C. Holdings, Inc.
With respect to IPA, the Arizona
Court of Appeals
held that:
Secondary marketing was a separate item of income with a separate IPA.
The direct costs included the salaries of the Colorado employees who conducted the secondary marketing.
The location of the customer (who purchased the mortgages) was not determinative. Slide23
MTC Reg. IV.18.(c)
Special
Rules: Sales Factor.
The following special rules
are established
in respect to the sales factor of the apportionment formula
:
[Included in the Sales Factor
]
Where
the income producing activity in respect to business income from intangible personal property can be readily identified, the income is included in the denominator of the sales factor and, if the income producing activity occurs in this state, in the numerator of the sales factor as well. Slide24
MTC Reg. IV.18.(c)(3)[Excluded from the Sales Factor]
Where business income from intangible property cannot readily be attributed to any particular income producing activity of the taxpayer, the income cannot be assigned to the numerator of the sales factor for any state and shall be excluded from the denominator of the sales factor.
For
example, where business income in the form of dividends received on stock, royalties received on patents or copyrights, or interest received on bonds, debentures or government securities results from the mere holding of the intangible personal property by the taxpayer, the dividends and interest shall be excluded from the denominator of the sales factor.
Arizona’s version: A.A.C. R15-2D-903(3)
Arizona’s version: A.A.C. R15-2D-903(3)Slide25
Issues with Sales of Services and Intangibles
What is an item of income?
Classes of income vs. individual items
Implications of each approach for states and taxpayers.
What is reasonable?Slide26
Issues with Sales of Services and Intangibles
What is an income producing activity?
Employees vs. agents and contractors
Sales activities vs. production activities
Situsing
of an income producing activity
People vs. machinesSlide27
Issues with Sales of Services and Intangibles
Cost of Performance vs. Market States
Market states: customer location vs. benefit of service
Effect of delivering sales across both types of states
Effect on Arizona of
Heller Western
caseSlide28
Issues with Sales of Services and Intangibles
Troublesome Industries
Information Technology including SaaS,
PaaS
and
IaaS
Financial services
Mergers and acquisitions including GoodwillSlide29
Arizona Multistate Service Provider
Laws 2012, Chapter 2, § 1, effective for taxable years from and after 12/31/2013 (SB 1046)
Provided for a phased-in market based sales for qualifying taxpayers.
Criteria must be met and election required.
Election binding for 5 consecutive taxable years.
Must meet the criteria again to renew election at 5 years intervals.Slide30
Arizona Multistate Service ProviderElection (Form MSP, PART A)
DRAFTSlide31
Arizona Multistate Service ProviderCalculation (Form MSP, PART B)
DRAFTSlide32
Arizona Multistate Service ProviderArizona Form 120, Question F
DRAFTSlide33
Arizona Multistate Service ProviderArizona Form 120, Schedule E
DRAFTSlide34
Alternative Apportionment
Methodology
-- Explanation
Standards for Invoking
Mathematical vs. “I know it when I see it”
What to Measure Against? Slide35
Alternative Apportionment - Explanation
History:
UDITPA § 18
- “permit the use of methods different from those prescribed in the Act only in unusual cases and in cases where the application of specifically prescribed methods might be held unconstitutional.”
Traditional State Apportionment - Various
t
hree-factor formula made up of
property
,
payroll
and
sales
Alternative Apportionment – permits use of alternative method(s) if standard does not “fairly represent” taxpayer’s business in state.
For example: Separate Accounting, Exclusion/inclusion of factors, or Catch all - “Employment of any other method to effectuate an equitable allocation and apportionment of income.” Slide36
Alternative Apportionment – Standards for Invoking
Distortion?
CA
Standard: Qualitative and Quantitative Distortion
Reasonable
Alternative?
Likely “reasonable
” when the party asserting alternative apportionment is able to show a close
connection between
the basis for deviating from the standard formula
AND the proposed alternative method
.
Burden of Proof?
Generally, the party
seeking to
apply alternative
apportionment
carries the
burden of
proving that
1)
distortion exists and 2
)
the proposed alternative is
reasonable
.
Clear and Convincing Evidence
: California -
Microsoft
Preponderance of the Evidence
: Oregon -
Twentieth
Century-Fox
Clear and Cogent Evidence
: New York –
British Land (Maryland) Inc.
Prima Facie
EvidenceSlide37
Alternative Apportionment - Mathematical vs. “I know it when I see it
”
Appeal
of Merrill, Lynch
, 89-SBE-017 (2 June 1989).
Franchise Tax Board (FTB) did not demonstrate the difference
between
apportionment rises
to
level
of distortion such that appellant's business activity in
CA is
unfairly reflected by
standard formula
. . .
Largest
difference between
apportionment
formula percentage as computed using
FTB's
method and
using standard
methods was for 1973, when FTB's method produced a final California apportionment formula of
5.8637%,
and
standard
method produced a final formula of
3.4323%…
[D]
ifference
of only 2.4314. . .
much
too slight to be justification for application of §25137
.Slide38
Alternative Apportionment - Mathematical vs. “I know it when I see it”
Hans Rees' Sons, Inc. v. North Carolina, 283 U.S. 123 (1931)
250
%
variance between formulary
apportionment and
taxpayer’s
calculation was deemed “out of all appropriate proportion to the business transacted by the [taxpayer] in that State.”
Hess Realty Corp. v. Dir., Div. of Taxation, New Jersey Dept. of Treasury, 10 N.J. Tax 63 (Tax Ct. 1988)
New
Jersey, 200% distortion generally is threshold for distortion
.
Director “has an obligation to adjust a particular allocation formula if
it
is unfair in that it does not ‘effect a fair and proper allocation of the [taxpayer’s] entire net income and the entire net worth reasonably attributable to the State
’.”
Media General
Comm.
v. South Carolina Dep’t of Revenue, No. 07-ALJ-17-0089-CC
(S.C. Admin. Law Ct. 4 May 2009),
aff’d
694 S.E.2d 525 (S.C. 2010)
435
%
differential found to be distortive. Slide39
Alternative Apportionment – What to Measure Against?
What
type of evidence
is acceptable for party seeking to demonstrate Single Sales Factor (SSF) apportionment unfairly represents business in the state?
Separate accounting has
been widely rejected as
means
of
establishing distortion.
So what should be measured?
Fair apportionment
demands factors
used in
formulary
apportionment must actually reflect a reasonable sense of how income is
generated.Slide40
Notable Cases, Statutes
Moorman Manufacturing Co. v. Bair, Director of Revenue of Iowa
Constitutionality of non-traditional factors (i.e
.,
single sales factor)
Hans Rees’ Sons v. State of North Carolina
Constitutionally permissible alternate apportionment methodology may
violate application for particular
taxpayer
Twentieth Century-Fox Film Corp. v.
Dept
of Revenue
Instruction on
reasonableness
of
alternative
formula
Microsoft Corp.
v. FTB
;
&
General
Mills Inc
.,
et al. v.
FTB
Proving fairness and reasonableness of
alternative
apportionment formula (i.e
.,
what is includable in the sales factor)Slide41
Questions?