Tax Executives Institute NJ Chapter

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Tax Executives Institute NJ Chapter

• Current Issues in Apportionment
• Gary C. Bingel
• bingel_at_amper.com
• Stephen J. Bercovitch
• bercovitch_at_amper.com

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Contents

• Constitutional Background
• Issues with Apportioning Sales Other Than Those
  from the Sale of Tangible Personal Property
• Alternative Apportionment Relief
• Apportionment Issues with Flow-through Entities

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Constitutional Background

• Due Process Clause concerned with fundamental
  fairness and notice
• Must be some minimal connection (slightest
  presence) between the state and activities the
  state is seeking to tax (including the taxpayer
  itself) and
• Must be a rational relationship between the
  income attributed to the interstate and
  intrastate values of the entity.

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Constitutional Background

• Commerce Clause
• Must be substantial nexus with the state
• Tax must be fairly apportioned
• Internal consistency test
• Tax must not discriminate against interstate
  commerce
• Tax must be fairly related to the services
  provided by the state and how income is earned.
• External consistency test

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Overriding Constitutional Questions

• When evaluating apportionment formulas, the
  following should always be included in the
  thought process
• Is the income being taxed rationally related to
  the value connected with the state and the
  benefits received?
• Are material income-producing factors excluded or
  disproportionately weighted?
• Discrimination?

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Apportioning Receipts Other than from the Sale of
TPP
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Alternative Apportionment Relief

• UDITPA Section 18
• If the allocation and apportionment provisions of
  this Act do not fairly represent the extent of
  the taxpayers business activity in this state,
  the taxpayer may petition for or the tax
  administrator may require, in respect to all or
  any part of the taxpayers business activity, if
  reasonable
• Separate accounting
• The exclusion of any one or more of the factors
• The inclusion of one or more additional factors
  which will fairly represent the taxpayers
  business activity in this state, or
• The employment of any other method to effectuate
  an equitable allocation and apportionment of the
  taxpayers income.

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Alternative Apportionment Relief

• Contrast UDITPAs business activity language
  (CA, NJ, NY, PA) with other states (CT, DE, MD)
  that reference a taxpayers income.
• Language often interchanged E.g. MDs statute
  references a taxpayers income, while the
  regulation references business activity.
• Some states use or language (business activity
  or income). E.g., NJ NY
• Differences between locations of a companys
  business activity and where income is earned.
• Some states provide for only the state to seek an
  alternative method and not the taxpayer (MD).

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Alternative Apportionment Relief

• Current Application
• Single Factor Constitutionality?
• Moorman Mfg. Co. v. Blair, 437 U.S. 267 (1978)
• This case was NOT decided under current internal
  / external consistency framework, which didnt
  come into place until five years later in
  Container Corp. of America v. FTB, 463 U.S. 159
  (1983).
• Case was also decided primarily on the failure to
  establish a base against which single-factor
  could be measured.

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Alternative Apportionment Relief

• Current Application
• Single Factor / Heavily Weighted Receipts /
  Throw-back / Throw-out
• Do these formulas reasonably reflect how income
  is earned? External consistency?
• Are a companys property and payroll irrelevant
  to how a company earns its income? Arent they a
  significant measure of a companys business
  activities?
• Why do the laws of another state effect how your
  income is earned in another state?
• Are these formulas discriminatory?
• Look to statements of legislators!

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Alternative Apportionment Relief

• Recent Case
• In the Matter of Infosys Technologies, Ltd, NY
  tax App Tribunal (2/21/08)
• India-based software firm was not allowed to
  utilize a separate accounting method to calculate
  its income for NY purposes, and was required to
  use worldwide income as its tax base.
• The use of an alternative receipts factor was
  also denied.
• Taxpayer was allowed to adjust its payroll factor
  based on the ratio of NY billable employees to
  total billable employees, due to disparate pay
  rates between NYC and India.

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Alternative Apportionment Relief

• Sword Cuts Both Ways
• Even if you follow a states statutory guidance,
  the state may use these same arguments to alter
  your apportionment calculation.
• Microsoft Corp. v. FTB, CA Supreme Ct. No
  S133343. 39 Cal.4th 750) (8/17/06) and other
  treasury function receipts cases.
• In Microsoft, even though gross receipts
  marketable securities transactions may be
  properly included in the receipts factor, such
  inclusion would be distortive. Therefore, the
  apportionment formula was modified to include
  only the net proceeds in the receipts factor.

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Alternative Apportionment Relief

• How do you Obtain Relief?
• Some states have defined methods of seeking
  relief
• NY NJ Require pre-approval from the Dept of
  Rev. Taxpayer must file report using statutory
  formula. A request to vary the formula must be
  attached, along with the related computation and
  reasons for the variance.
• MD separate accounting permitted if
  practicable.
• PA requires a taxpayer to petition the
  department for use of an alternative formula.
  However, no further guidance is given.
• For other states it is often not clear how relief
  is sought.
• File, file and disclose, disclose through amended
  return?

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Alternative Apportionment Relief

• Timing?
• Is pre-approval required before utilizing
  alternative formula?
• CA / NY / NJ all require taxpayer to receive
  approval before the filing date of the return.

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Alternative Apportionment Relief

• Other Issues for Obtaining Relief
• Establishment of Baseline
• Most cases are decided based on the inability to
  establish a proper baseline (See, e.g., Unisys v.
  PA, 812 A.2d 448 (10/25/02)), but how is such a
  baseline determined?
• Use of economists?
• Separate Accounting?
• Burden of Proof?
• Clear and Convincing?
• Other?

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Flow Through Entity Issues

• Many more states are taxing flow-through entities
  directly
• OH
• MI
• TX
• NH
• TN
• Phila
• NYC

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Flow Through Entity Issues

• Threshold question is there jurisdiction to tax
  the owners of flow-through entities under the Due
  Process Clause?
• The owners of flow-through entities are legal
  entities separate and apart from the pass-through
  entities themselves. Thus, a question exists as
  to whether under the Due Process Clause a state
  can require an owner to treat income from a
  flow-through entity as apportionable income
  absent a unitary relationship.
• One factor to consider is whether flow-through
  treatment was elective (eg, S corps).
• Is there limited liability?
• Does the flow-through serve a purely investment
  function?
• Is ownership less than 50

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Flow Through Entity Issues

• Assuming the jurisdiction has the right to tax
  the owners, how are apportionment factors
  calculated?
• Flow-through of all factors? (Typical treatment)
• Unitary relationship? Some states (e.g., CA)
  require a flow-through of factors when a unitary
  relationship exists.
• Other special rules e.g., previously IL did not
  deem second tier partnerships unitary and thus
  did not flow-up factors more than one level.
• Elimination of intercompany transactions with
  partnership? IL DOR Ruling IT 08-0001-PLR
  (5/19/08)
• Distributive share as gross receipt?
• Specific allocation of pass-through income
• LA / MS / OK all require partnership income to be
  specifically allocated based on where earned.

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Flow Through Entity Issues

• Determination of Business / Non-business Income
• At the partnership level IL
• At the partners level PA
• Most states dont address

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Flow Through Entity Issues

• Calculation of Throw-back / Throw-out and Joyce /
  Finnigan issues
• Is the determination made at the partnership
  level or the partner level when determining sales
  to be thrown back / out?
• Joyce states each entitys apportionment
  factors are calculated independent of the others,
  and then combined. Thus, a partnerships sales
  to a state where it doesnt have nexus may be
  subject to throwback despite the fact that the
  corporate partner has nexus in such state.