Single Sales Apportionment: Crafting a Multi State Strategy - - PowerPoint PPT Presentation

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Single‐Sales Apportionment: Crafting a Multi‐State Strategy Crafting a Multi State Strategy

Meeting Tax Compliance and Planning Demands Amid Significant Changes in Sales Weighting

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific THURSDAY, OCTOBER 6, 2011

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Kirk Lyda Partner Jones Day Dallas Texas Kirk Lyda, Partner, Jones Day, Dallas, Texas Mark Nachbar, Principal, Ryan, Downers Grove, Ill. Sarah McGahan, Senior Manager, Washington National Tax, KPMG, Los Angeles

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Si l S l A ti t C fti Single‐Sales Apportionment: Crafting a Multi‐State Strategy Seminar

• Oct. 6, 2011

Sarah McGahan, KPMG

smcgahan@kpmg.com

Kirk Lyda, Jones Day

klyda@jonesday.com

Mark Nachbar, Ryan

mark.nachbar@ryanco.com

Today’s Program

Roots Of The Single-Sales Apportionment Trend

[Kirk Lyda]

Slide 7 – Slide 21 Concurrent State Trends And Issues With An Impact

[S arah McGahan]

Slide 22 – Slide 31 Resulting Planning Options To Consider

[Mark Nachbar]

Slide 32 – Slide 39

ROOTS OF THE SINGLE SALES

Kirk Lyda, Jones Day

ROOTS OF THE SINGLE‐SALES APPORTIONMENT TREND

T d H Did W G H ? Trend: How Did We Get Here?

• 1950s and 1960s – State efforts to export tax burden

― Income tax nexus Si l l ti t ― Single-sales apportionment

• Congressional/business reaction (1960s and forward)

Public Law 86 272 ― Public Law 86-272 ― Use of other factors

• History repeats itself (1990s and forward)

History repeats itself (1990s and forward) ― Aggressive income tax nexus ― Single-sales apportionment

8

Northwestern States (1959): Income Tax Nexus

9

Reaction: P.L. 86‐272 (1959)

10

GM v. DC (1965): Questioning Single‐Sales

11

GM v. DC (1965): Questioning Single‐Sales (Cont.)

12

Willis Report (1964): Questioning Single‐Sales

13

UDITPA Th F UDITPA: Three‐Factor

14

Moorman v. Bair (1974): Single Factor Upheld

15

Moorman v. Bair (1974): Single Factor Upheld (Cont.)

16

Si l S l F I li i Single‐Sales Factor: Implications

• An increased weight in the sales factor rewards companies

exporting products from the state.

• and taxes more heavily those that produce products

… and taxes more heavily those that produce products elsewhere and sell into the state. Source: Federation of Tax Administrators, Revenue Estimating Conference (2004) Conference (2004)

17

Si l S l F T d Single‐Sales Factor: Trend

• 1980s: Roughly 10 states shifted to double-weighted sales

factors.

• 1990s: Roughly 25 states had shifted to double-weighted sales

1990s: Roughly 25 states had shifted to double weighted sales factors.

• 1990s: Roughly five states had shifted to single-sales factors.
• 2000 forward: 18-plus states increase weights of sales factors.
• 2000 forward: Seven-plus states shift to single-sales factors.

Source: Federation of Tax Administrators, Revenue Estimating Conference (2004) ( )

18

National Trend: Single‐Sales Factor Epidemic

19

National Trend: Single‐Sales Factor Epidemic (Cont.)

20

l l Single‐Sales Factor: Recent Converts

• Florida HB 143 (effective with tax years after 2012)
• Elective if meet capital contribution requirements ($250M) to qualify
• New Jersey SB 2753

Phased in for several years ― Phased in for several years ― Single-sales factor for privilege periods after Jan. 1, 2014

• California (2009)

― Elective single sales factor ― “Reconsideration” failed

• Arizona HB 2001

― Phased in for several years ― Single-sales factor by 2017 O h ?

• Others?

21

CONCURRENT STATE TRENDS

Sarah McGahan, KPMG

CONCURRENT STATE TRENDS AND ISSUES WITH AN IMPACT

C Of P f T Cost Of Performance Test

• Traditionally. sales of other than tangible personal property are

sourced using an income producing activity (IPA) test.

• Receipts attributed to state where greater proportion of

ece pts att buted to state w e e g eate p opo t o o IPA occurred, based on cost of performance (COP) Test applied to each item of income

• What is an item of income? A transaction? An entire

business? Cost of performance Cost of performance

• Direct costs in accordance with GAAP
• What are direct costs?

23

R C Recent Cases

A T&T Corp. v. Dep’t of Revenue (Mass. App. Tax Bd. June 8, 2011) p p f

( pp , )

• The issue before the Board was whether the income-producing activity test

applied broadly to the taxpayer’s overall service of providing telecommunications services to Massachusetts customers, or whether it should be applied narrowly to each transaction (i.e., call or data transmission).

• The Board, rejecting the Revenue Department’s use of a

t ti l h h ld th t th t t t b li d t th transactional approach, held that the test must be applied to the taxpayer’s overall operations.

• The ATB also held that access fees paid to local exchange carriers

(LEC ) t di t t i l d d i d t i i th t ’ (LECs) were not direct costs included in determining the taxpayer’s costs of performance.

• Rather, the access fees were for payment of activities

f d th t ’ b h lf b th LEC d performed on the taxpayer’s behalf by the LECs and were therefore excluded.

24

R C (C ) Recent Cases (Cont.)

A T&T v. Dep’t of Revenue (Or. Tax Ct. June 28, 2011)

• The issue before the court was whether the cost of performance analysis applied

to the taxpayer’s overall service of providing interstate and international calls or to each individual call to and from Oregon.

• The court held that the test narrowly applied on a transactional basis

(i.e., to each call to and from Oregon).

• Next, the court held that only direct costs incurred regarding any given phone

call should be considered in determining costs of performance call should be considered in determining costs of performance.

• As such, no general and administrative costs were counted.
• Finally, the court held that costs paid to local exchange carriers (LECs) were

“direct costs” counted in determining cost of performance “direct costs” counted in determining cost of performance.

• An Oregon rule in effect at the time excluded costs performed by

independent contractors “on behalf of” a taxpayer.

• In the court’s view there was a difference between activities performed
• In the court s view, there was a difference between activities performed

“on behalf of,” and performed “for,” a taxpayer.

25

M T M k B d S i Move To Market‐Based Sourcing

Alabama H.B. 434 (signed June 9, 2011)

• Effective for tax years taxable years beginning on or after Dec. 31,

2010, H.B. 434 makes the following changes:

• Increases the weight of the sales factor to 50%
• Replaces the income-producing activity/cost of performance

test with market-based rules for service and intangible receipts test with market based rules for service and intangible receipts

• Adopts a so-called “throwout” rule
• If the taxpayer is not taxable in a state to which receipts

i d d h k b d i i i are assigned under the market-based sourcing provisions, or if the state of assignment cannot be determined or reasonably approximated, then the receipts are excluded entirely from the denominator of the sales factor entirely from the denominator of the sales factor.

26

Move To Market‐Based Sourcing (Cont.)

• For tax years beginning on or after Jan. 1, 2011, if a taxpayer elects

SSF , sales (other than those of tangible personal property) are in California as follows:

• Sales from services are in California to the extent the purchaser
• f the service received the benefit of the service in the state.
• Sales from intangible property are in California to the extent

the property is used in the state. In the case of marketable securities, sales are in California if the customer is in California.

• Sales from the sale, lease, rental or licensing of real property

, , g p p y are in California if the real property is situated in the state.

• Sales from the rental, lease or licensing of tangible personal

property are in California if the property is situated in the state property are in California if the property is situated in the state.

27

Move To Market‐Based Sourcing (Cont.)

• Other states that have recently moved to market-based sourcing:

y g

• Illinois: Effective for tax years ending on or after Dec. 31, 2008
• Maine: Effective for tax years beginning on or after Jan. 1, 2007
• Oklahoma: New regulation effective July 11, 2010
• Utah: Effective for tax years beginning on or after Jan. 1, 2009
• Washington: Effective June 1 2010 for taxpayers engaged in

Washington: Effective June 1, 2010 for taxpayers engaged in apportionable activities

• Wisconsin: (For intangible income) effective Oct. 1, 2009

28

I O 8 / C i Impact On 80/20 Companies

• In a number of states, certain domestic or foreign entities are included

, g in the water’s edge combined group if they have a certain amount of factors in the U.S.

• Thus, a state's given approach for determining the sales factor

, g pp g (i.e., COP , or market-based sourcing) will affect which entities are included in the water-edge group, because they have a certain amount of activity in the U.S.

• Differences in state apportionment approaches could result in

different classifications depending on the states.

• Examples
• Examples
• The water’s-edge group in CA, DC, MA or WV includes any group

member, regardless of where incorporated or formed, if the average of the member’s property payroll and sales factors in average of the member s property, payroll and sales factors in the U.S. is 20% or more.

29

( ) Impact On 80/20 Companies (Cont.)

• In Illinois, unitary group does not include domestic members for which

, y g p 80% or more of business activity is conducted outside U.S.

• Business activity within the U.S. is measured by the factors
• rdinarily applicable under subsections (a), (b), (c), (d), or (h) of

y pp ( ), ( ), ( ), ( ), ( ) 35 ILCS § 5/304. (i.e. the Illinois apportionment factors).

• Thus, if 20% or less income is apportioned to Illinois, the

member can be excluded. member can be excluded.

• In the case of members ordinarily required to apportion business

income by means of the three-factor formula of property, payroll and sales such members shall not use the sales factor in the and sales, such members shall not use the sales factor in the computation, and the results of the property and payroll factor computations shall be divided by two (by one if either the property or payroll factor has a denominator of zero). property or payroll factor has a denominator of zero).

30

C i i Of U i G Composition Of Unitary Groups

• Different state approaches for entities required to use different

apportionment methodologies due to the nature of their business

• Massachusetts: Entities required to use different

Massac usetts: t t es equ ed to use d e e t apportionment formulas (manufacturing companies, financial institutions) are combined in a single unitary group group.

• Certain adjustments are made to the factors.
• West Virginia: Entities required to use different

g q apportionment methodologies comprise a mini-unitary group.

31

RESULTING PLANNING

Mark Nachbar, Ryan

OPTIONS TO CONSIDER

Al i A i Alternative Apportionment

Taxpayers that are negatively affected by single-factor apportionment can appeal for alternative apportionment under two standards:

• Constitutional standard for relief
• UDITPA Sect. 18 standard

33

C i i l S d d Constitutional Standard

Background

• A constitutional tax must meet the four prongs of Complet e

Aut o Transit :

― Substantial nexus ― Fairly apportioned N di i i i i ― Not discriminate against interstate commerce ― Be fairly related to the services performed by the state

• Apportionment is fair if it is:

Apportionment is fair if it is: ―

Cont ainer Corporat ion

― Internally consistent ― Externally consistent

34

C i i l S d d (C ) Constitutional Standard (Cont.)

Apportionment formula upheld even when it may result in the taxation of some income that did not have its source in the taxing state.

• Moorman Mfg. Co.

Moorman Mfg. Co.

• Single-sales-factor not facially unconstitutional
• No evidence impeaching fairness of methodology

p g gy Apportionment formula found invalid if it is “arbitrary and unreasonable.”

H R ’ S

• Hans Rees’ S
• ns
• Single property factor invalidated
• “As applied ” the formula operated create an
• As applied, the formula operated create an

unreasonable result.

35

UDITPA S 8 UDITPA Sect. 18

Enacted to permit the tax administrator to require or allow Enacted to permit the tax administrator to require or allow alternative formula when the standard formulae do not fairly represent the extent of the taxpayer’s business in the state. l h d l Alternative methodologies

• Separate accounting
• The exclusion of any one or more of the factors
• The exclusion of any one or more of the factors
• The inclusion or one or more additional factors
• The employment of any other reasonable method

p y y ― Unitary filing permitted ―

Media General Communicat ions, Inc. v S

• ut h

Carolina, (South Carolina Supreme Court, 2010)

36

Indications Of Unfair Apportionment

Use of separate accounting

• Hans Rees’ S
• ns
• Moorman Mfg Co
• Moorman Mfg. Co.
• Rejected in Exxon and Mobil
• Separate accounting alone will not support alternative

Separate accounting alone will not support alternative apportionment, as this was the method withdrawn in favor

• f formulary apportionment.

―

In re: Appeal of Crist a Corp. (California State Board

• f Equalization, No. 2002-SBE-004, June 20, 2002)

37

Indications Of Unfair Apportionment (Cont.)

Factor does not represent income earned in the state. p

• Treasury receipts

―

Microsoft v. FTB, (California Supreme Court, 2006)

Mi i g f t Missing factor

• Inventory

―

Georgia v. Coca-Cola Bot t ling Co. (GA Supreme Court, 1956)

• Intangibles

―

Microsoft V . FTB, (San Francisco Superior Court Case No.

CGC08471260, 3/21/11, case appealed to the California Court of , , pp Appeals)

• Futures contracts

―

General Mills v FTB (California Court of Appeals 2009;

―

General Mills v. FTB, (California Court of Appeals, 2009;

remanded California Superior Court)

38

A li i T Si l S l F Application To Single‐Sales Factor

Single-sales factor facially constitutional

• Moorman

Need to show the apportioned result is “out of all proportion to Need to show the apportioned result is out of all proportion to the business transacted” or has “led to a grossly distorted result”

Colgat e-Palmolive, (Illinois Circuit Court, 2002)

• Intangible property accounted for in the payroll and

property factors used to create the intangibles

• Now that Illinois is a single sales factor state would this
• Now that Illinois is a single-sales-factor state, would this

ruling still hold?

39