state corporate income apportionment key...

State Corporate Income

Apportionment Key Fundamentals Understanding Trends and State Approaches to Factor Weighting,

Service Revenue, Joyce vs. Finnigan and Other Apportionment Concepts

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WEDNESDAY, MAY 15, 2013

Presenting a live 110-minute teleconference with interactive Q&A

Richard Call, Attorney, Morrison & Foerster, New York

Kelly Brown, Director, State and Local Tax Group, PricewaterhouseCoopers, Boston

Marianne Evans, Senior Manager, KPMG, Washington, D.C.

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State Corporate Income Apportionment Key Fundamentals Seminar

Kelly Brown, PricewaterhouseCoopers

[email protected]

May 15, 2013

Richard Call, Morrison & Foerster

[email protected]

Marianne Evans, KPMG

[email protected]

Today’s Program

Business Vs. Non-Business Income

[Richard Call]

Apportionment Formula Key Concepts

[Richard Call]

Sales Factor

[Kelly Brown and Marianne Evans]

Property Factor

[Richard Call]

Payroll Factor

[Marianne Evans]

Specific Industry Apportionment

[Kelly Brown]

Combined/Consolidated Return Issues

[Richard Call]

Latest Important Developments

[Kelly Brown]

Slide 8 – Slide 10



Slide 51

Slide 11– Slide 14




Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

BUSINESS VS. NON-BUSINESS INCOME


9

Apportionable V. Non-Apportionable Income

• Constitutional framework

• Apportionment formula may only apply to “apportionable” income.

• The U.S. Constitution prohibits a state from apportioning income

that has no connection to the taxing state.

• Statutory framework

• Many states use a statutory term, “business income,” to

determine what income is apportioned to the state.

• Non-apportionable or non-business income can be specifically

allocated by statute.

10

What Is Apportionable Income?

• Constitutional framework

• To be apportionable, income must come from a “unitary” business.

• Indicators of a unitary business are flows of value, which have been

expressed as:

• Functional integrations

• Centralization of management

• Economies of scale

• Statutory framework

• Historically, “business income” was defined in UDITPA as “income arising

from transactions and activity in the regular course of the taxpayer’s trade or

business and includes income from tangible and intangible property if the

acquisition, management, and disposition of the property constitute integral

parts of the taxpayer’s regular trade or business operations.”

• Some states define “business income” as all income apportionable under the

Constitution.

APPORTIONMENT FORMULA KEY CONCEPTS


This is MoFo. 12

Apportionment

U.S. Supreme Court precedent has interpreted the Commerce Clause to require fair apportionment.

What is fair apportionment?

Do taxpayers have a right to apportion? If so, when?

Apportionment formula must reasonably reflect how income is generated.

This is MoFo. 13

What Factors Are Used?

This is MoFo. 14

Weighting Of Factors

SALES FACTOR



Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED

OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED,

BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE

PURPOSE OF (i) AVOIDING

PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii)

PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER

PARTY ANY MATTERS ADDRESSED HEREIN.


without limitation, the tax treatment or tax structure, or both, of any transaction described in

the associated materials we provide to you, including, but not limited to, any tax opinions,

memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be determined

through consultation with your tax adviser.

16

Sales Factor: What Is Included?

I. UDITPA refers to “total sales” but defines “sales” as “all gross

receipts of the taxpayer not allocated.”

II. The MTC regulations specify that “sales” includes “all gross

receipts derived by the taxpayer from transactions and

activity in the regular course of the trade or business.”

17

Sales Factor: What Is Excluded?

I. MTC regulations exclude:

A. Substantial amounts of gross receipts from the occasional

sale of fixed assets used in the taxpayer’s business

B. Insubstantial amounts that do not materially affect the

factors

C. Receipts on which the IPA cannot be localized

II. States have specific exclusions:

A. Receipts other than receipts from the principal business

activity

B. Receipts from sale of certain assets

C. Receipts from income not included in the tax base

18

Slide Intentionally Left Blank

Sales Factor: Gross Receipts Or Net Gain?

I. UDITPA and the MTC regulations refer to “gross receipts.”

II. However, the MTC regulations were amended in 2001 and now

provide that only the “overall net gain” from the sale,

exchange or other disposition of “liquid assets” in a taxpayer’s

“treasury function” are included.

A. Only a few states have adopted this modification to the

MTC regulations (e.g., HI, ID, UT).

B. Other states have similar rules that allow inclusion of only

net gains on sales of intangible property (e.g., IL).

20

Sales Factor: Sourcing Of Sales Of TPP

I. UDITPA

A. Sales of TPP are in this state if the property is delivered or

shipped to a purchaser, other than the U.S. government,

within this state.

II. MTC regulations

A. Does not matter if the property is ordered from another

location

B. Does not matter if purchaser subsequently transfers the

property to another state

C. Drop shipments: Sourced to where the ultimate recipient

of the property is situated (your customer’s customer)

21

Sales Factor Sourcing: Dock Pick-up Sales

I. “… delivered or shipped to a purchaser … within this state”

A. Does “within this state” modify “delivered or shipped” or

“purchaser”?

II. If the purchaser picks up goods at seller’s dock and then

transports them to another state for use, to which state are

the sales sourced?

A. Most state courts have held that such sales are sourced to

the state of ultimate destination.

22

Sales Factor: Throwback

I. UDITPA

A. Sales of TPP are in this state if the property is shipped from an

office, store, warehouse, factory or other place of storage in this

state, and the taxpayer is not taxable in the state of the

purchaser.

II. How do UDIPTA and/or the MTC regulations define “taxable in the

state of the purchaser”?

A. Being subject to a net income tax, franchise tax for the privilege

of doing business, or a corporate stock tax in another state

B. Another state having the right to impose a net income tax, even

if it does not actually impose such a tax

23

Sales Factor: Sourcing Of Non-TPP Sales

I. UDITPA

17

A. Sales, other than sales of TPP, are in this state if:

1. The income-producing activity (IPA) is performed in

this state, or

2. The IPA is performed both in and outside this state,

and a greater proportion of the IPA is performed in this

state than in any other state based on costs of

performance.

24

Sales Factor: Definitions

I. IPA - MTC Reg. IV.17.(2)

A. IPA “applies to each separate item of income and means

the transactions and activity directly engaged in by the

taxpayer in the regular course of its trade or business for

the ultimate purpose of obtaining gains or profits.”

II. Costs of performance - MTC Reg. IV.17.(3)

A. Direct costs determined in a manner consistent with

generally accepted accounting principles and in

accordance with accepted conditions or practices in the

trade or business of the taxpayer

25

Sales Factor: Market-Sourcing Issues

I. How do you determine where a service is received?

II. How do you define the benefit of a service?

III. How do you determine where the benefit is received?

IV. When do you “look through” to the ultimate customer or

ultimate marketplace?

V. What is a fixed or regular place of business?

26

PROPERTY FACTOR


This is MoFo. 28

Property Factor

Uniform Division of Income for Tax Purposes Act (UDITPA)

Owned and leased real and tangible personal property are included

in the factor.

Owned property is valued at its original cost unless original cost is

not known; then, FMV at time of acquisition is used.

Leased property is valued at 8 times the annual rental amount.

The factor is determined by using an average of beginning- and end-

of-year values.

Storage fees – Multistate Tax Commission Reg. IV.11(b)(3)

“A taxpayer stores part of its inventory in a public warehouse. The

total charge for the year was $1,000 of which $700 was for the use of

storage space and $300 for inventory insurance, handling and

shipping charges, and C.O.D. collections. The annual rent is $700.”

This is MoFo. 29

Property Factor (Cont.)

Movable property

Multistate Tax Commission Reg. IV.10(d)

“The value of mobile or movable property such as construction

equipment, trucks or leased electronic equipment which are

located within and without this state during the tax period shall be

determined for purposes of the numerator of the factor on the

basis of total time within the state during the tax period.”

“An automobile assigned to a traveling employee shall be

included in the numerator of the factor of the state to which the

employee's compensation is assigned under the payroll factor or

in the numerator of the state in which the automobile is licensed.”

This is MoFo. 30

Property Factor (Cont.)

In-transit property

“Property in transit between locations of the taxpayer to which it

belongs shall be considered to be at the destination for purposes of

the property factor.” Cal. Code Regs. tit. 18,

25129(d)

Inventory in transit from one state to another is not included in the

denominator of the property factor. N.J. Admin. Code

18:7-8.4(c)(3)

Maryland required inclusion of the value of automobiles on the high

seas in the Maryland numerator, despite the fact that in-transit

inventory was not addressed in the property factor statute.

Mercedes Benz of N. Am., Inc. v. Comptroller of Treasury, Dkt. No.

2813, (Md. Tax Ct. Oct. 7, 1988)

This is MoFo. 31

Property Factor For Banks

Loans in property factor

Minnesota - Minn. Stat.

290.191, Subd. 11

Secured loans are attributable to Minnesota if the security is in

Minnesota.

Unsecured consumer loans or consumer loans secured by

intangibles are attributed to Minnesota if the loan was made to a

resident of Minnesota.

Unsecured commercial loan and installment obligations are

attributable to Minnesota if the proceeds of the loan are to be

applied in Minnesota.

Loans will generally include credit card receivables.

This is MoFo. 32

Property Factor For Banks (Cont.)

Loans in property factor (Cont.)

MTC

A loan is considered to be located within this state if it is properly

assigned to a regular place of business of the taxpayer within this state.

A loan is properly assigned to the regular place of business with which it

has a preponderance of substantive contacts.

To determine the state in which the preponderance of substantive contacts relating to a loan have occurred, the facts and circumstances regarding the loan at issue shall be reviewed on a case-by-case basis and consideration shall be given to such activities as:

Solicitation

Investigation

Negotiation

Approval

Administration

This is MoFo. 33

Property Factor

Meredith Corp. (N.Y. App. Div. 2012)

Is programming delivered via satellite TPP includable in the property

factor?

Policy change

When litigation commenced, programming delivered via videotape

was considered TPP by the department.

The department changed its policy via a TSB to exclude

programming delivered by videotape.

“This record establishes that programming on videotape had long been

considered by the Department as tangible property for purposes of the

property factor, and … there is no rational distinction for taxation

purposes between programming sent to a station on videotape and

programming sent via satellite.”

PAYROLL FACTOR


© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member fi rms affiliated with

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FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT

INTENDED OR WRITTEN BY KPMG TO BE USED, AND

CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON

OR ENTITY FOR THE PURPOSE OF (i) AVOIDING

PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR

(ii) PROMOTING, MARKETING OR RECOMMENDING TO

ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.


without limitation, the tax treatment or tax structure, or both, of any transaction described in the

associated materials we provide to you, including, but not limited to, any tax opinions,

memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are subject

to change. Applicability of the information to specific situations should be determined through

consultation with your tax adviser.

35




Payroll Factor: What Is Included?

Total amount paid to employees for compensation

− Includes salaries, commissions, other taxable remuneration

− Per the taxpayer’s accounting method – accrual or cash

− Includes payroll capitalized as part of cost of asset, for book or tax

purposes

− May elect to use cash method if compensation reported under cash

method for unemployment tax purposes

Payroll related to production of non-business income is excluded

Payroll paid to an employee in an “no-nexus”/P.L. 86-272 state is

included in denominator

36




Payroll Factor: What Is Included? (Cont.)

If the factor includes the total compensation paid to employees,

who qualifies as employees?

− Officers?

− Independent contractors?

− “Leased employees”?

− Others?

37




Hierarchy Of Payroll Sourcing

A. The state in which the employee’s services are wholly or substantially

performed, if services performed outside of that state are incidental

(temporary or transitory) or rendered in connection with isolated

transactions

B. The state in which the employee’s base of operations is located, if

some part of the services are performed in that state

C. The state from which the employee is directed or controlled, if some

part of the services are performed in that state

D. The state in which the employee resides

39

SPECIFIC INDUSTRY APPORTIONMENT


PricewaterhouseCoopers Slide 41

Special Industry Apportionment

• Three-factor formula works best for merchandising and manufacturing

businesses. States allow other formulas, by statute and by taxpayer

appeal.

• Construction: Include work in progress

• Athletes: Use duty-days

• Motion pictures: Use audience data

• Service providers: Use sales or payroll factors only

• Transportation: Use in-state miles, passenger-miles, train car-miles, ton-

miles, time in-port


Special Industry Apportionment (Cont.)

• Insurance companies: Use premium dollars written

• Mutual funds, banks: Use deposits, number of clients, number of cards

issued

• Communications: Use cable-miles, circulation, number of satellite

stations on the ground


Alternative Apportionment Method

• States may allow department to require, or taxpayer to request, use of an

alternative apportionment method.

• Usual goal is to prevent distortion or clearly reflect income in state.

COMBINED/CONSOLIDATED RETURN ISSUES


This is MoFo. 46

Combination

Combined report typically includes unitary members of the combined

group on either a worldwide or water’s edge basis.

Inter-company transactions within the group may be eliminated, for

apportionment purposes.

Joyce/Finnigan

Partnership factor flow-up

This is MoFo. 47

Combination (Cont.)

Appeal of Joyce (Cal. SBE 1966)

SBE held that a company’s receipts from sales of TPP, shipped to

California by a seller that was not taxable in California because of

P.L. 86-272 but was part of a unitary business conducted in California,

could not be included in the California sales factor numerator.

Joyce rule treats each combined group member as a separate entity, for

apportionment purposes. Unless an entity has stand-alone nexus, its sales

are not included in the sales factor numerator.

Effects – Combined group members may have to throw back sales not

subject to tax in other states in which other combined group members are

subject to tax.

This is MoFo. 48

Combination (Cont.)

Appeal of Finnigan (Cal. SBE 1990)

SBE overruled Joyce and held that when a combined group member

has sales to another state in which the combined group member is

not taxable, but in which other unitary combined group members are

taxable, the combined group member’s sales to that state are not

subject to throwback.

Finnigan rule treats all combined group members as one entity, for

apportionment purposes.

Effects – All combined group members’ sales that are sourced to

California are included in the numerator, regardless of whether the

individual combined group member is subject to tax in California.

This is MoFo. 49

Combination (Cont.)

Partnership factor flow-up

How does a state treat the apportionment factors of a partnership or

LLC when income from those entities is included in the tax base?

Are the factors of the partnership included in computing the tax?

California

Factors of the partnership flow up if the taxpayer and partnership

are engaged in a unitary business.

Factors of the partnership do not flow up if the partnership is in a

different line of business.

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