Single Sales Apportionment:

Transcription

1 Presenting a live 110 minute teleconference with interactive Q&A Single Sales Apportionment: Crafting a Multi State Strategy Meeting Tax Compliance and Planning Demands Amid Significant Changes in Sales Weighting THURSDAY, OCTOBER 6, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Kirk Lyda, Partner, Jones Day, Dallas, Texas Mark Nachbar, Principal, Ryan, Downers Grove, Ill. Sarah McGahan, Senior Manager, Washington National Tax, KPMG, Los Angeles For this program, attendees must listen to the audio over the telephone. Please refer to the instructions ed to the registrant for the dial-in information. Attendees can still view the presentation slides online. If you have any questions, please contact Customer Service at ext. 10.

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5 Single Sales S l Apportionment: t Crafting a Multi State Strategy Seminar Oct. 6, 2011 Kirk Lyda, Jones Day klyda@jonesday.com Sarah McGahan, KPMG smcgahan@kpmg.com Mark Nachbar, Ryan mark.nachbar@ryanco.com

6 Today s Program Roots Of The Single-Sales Apportionment Trend [Kirk Lyda] Slide 7 Slide 21 Concurrent State Trends And Issues With An Impact [Sarah McGahan] Slide 22 Slide 31 Resulting Planning Options To Consider [Mark Nachbar] Slide 32 Slide 39

7 Kirk Lyda, Jones Day ROOTS OF THE SINGLE SALES SALES APPORTIONMENT TREND

8 Trend: How Did We Get Here? 1950s and 1960s State efforts to export tax burden Income tax nexus Single-sales l apportionment t Congressional/business reaction (1960s and forward) Public Law Use of other factors History repeats itself (1990s and forward) Aggressive income tax nexus Single-sales apportionment 8

9 Northwestern States (1959): Income Tax Nexus 9

10 Reaction: P.L (1959) 10

11 GM v. DC (1965): Questioning Single Sales 11

12 GM v. DC (1965): Questioning Single Sales (Cont.) 12

13 Willis Report (1964): Questioning Single Sales 13

14 UDITPA: Three Factor 14

15 Moorman v. Bair (1974): Single Factor Upheld 15

16 Moorman v. Bair (1974): Single Factor Upheld (Cont.) 16

17 Single Sales S l Factor: Implications i An increased weight in the sales factor rewards companies exporting products from the state. and taxes more heavily those that produce products elsewhere and sell into the state. Source: Federation of Tax Administrators, Revenue Estimating Conference (2004) 17

18 Single Sales S l Factor: Trend 1980s: Roughly 10 states shifted to double-weighted sales factors. 1990s: Roughly 25 states had shifted to double-weighted sales factors. 1990s: Roughly five states had shifted to single-sales factors forward: 18-plus states increase weights of sales factors forward: Seven-plus states shift to single-sales factors. Source: Federation of Tax Administrators, Revenue Estimating Conference (2004) 18

19 National Trend: Single Sales Factor Epidemic 19

20 National Trend: Single Sales Factor Epidemic (Cont.) 20

21 Single Sales l 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 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 Oh Others? 21

22 Sarah McGahan, KPMG CONCURRENT STATE TRENDS AND ISSUES WITH AN IMPACT

23 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 e greater proportion o of 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 Direct costs in accordance with GAAP What are direct costs? 23

24 Recent Cases AT&T Corp. v. Dep t of Revenue (Mass. App. Tax Bd. June 8, 2011) 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 transactional ti approach, held that t the test t must be applied to the taxpayer s overall operations. 24 The ATB also held that access fees paid to local exchange carriers (LECs) were not direct costs included d in determining i the taxpayer s costs of performance. Rather, the access fees were for payment of activities performed on the taxpayer s behalf by the LECs and were therefore excluded.

25 Recent Cases (Cont.) AT&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. 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. 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 on behalf of, and performed for, a taxpayer. 25

26 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 Adopts a so-called throwout rule If the taxpayer is not taxable in a state to which receipts are assigned under the market-based sourcing provisions, i 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. 26

27 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 of 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 p 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. 27

28 Move To Market Based Sourcing (Cont.) Other states that have recently moved to market-based sourcing: 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 apportionable activities Wisconsin: (For intangible income) effective Oct. 1,

29 Impact On 80/20 Companies In a number of states, certain domestic or foreign entities are included 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 (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 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 the U.S. is 20% or more. 29

30 Impact On 80/20 Companies (Cont.) In Illinois, unitary group does not include domestic members for which 80% or more of business activity is conducted outside U.S. Business activity within the U.S. is measured by the factors ordinarily applicable under subsections (a), (b), (c), (d), or (h) of 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. 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 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). 30

31 Composition i Of Unitary Groups Different state approaches for entities required to use different apportionment methodologies due to the nature of their business Massachusetts: Entities t required ed to use different e apportionment formulas (manufacturing companies, financial institutions) are combined in a single unitary group. Certain adjustments are made to the factors. West Virginia: Entities required to use different apportionment methodologies comprise a mini-unitary group. 31

32 Mark Nachbar, Ryan RESULTING PLANNING OPTIONS TO CONSIDER

33 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

34 Constitutional i Standard d Background A constitutional tax must meet the four prongs of Complete Auto Transit: Substantial nexus Fairly apportioned Not discriminate i i against interstate commerce Be fairly related to the services performed by the state Apportionment is fair if it is: Container Corporation Internally consistent Externally consistent 34

35 Constitutional i Standard d (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. Single-sales-factor not facially unconstitutional No evidence impeaching fairness of methodology Apportionment formula found invalid if it is arbitrary and unreasonable. 35 Hans Rees Sons Single property factor invalidated As applied, the formula operated create an unreasonable result.

36 UDITPA Sect. 18 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. Alternative methodologies Separate accounting 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 Unitary filing permitted Media General Communications, Inc. v South Carolina, (South Carolina Supreme Court, 2010) 36

37 Indications Of Unfair Apportionment Use of separate accounting Hans Rees Sons Moorman Mfg. Co. Rejected in Exxon and Mobil Separate accounting alone will not support alternative apportionment, as this was the method withdrawn in favor of formulary apportionment. In re: Appeal of Crista Corp. (California State Board of Equalization, No SBE-004, June 20, 2002) 37

38 Indications Of Unfair Apportionment (Cont.) Factor does not represent income earned in the state. Treasury receipts Microsoft v. FTB, (California Supreme Court, 2006) Missing i factor Inventory Georgia v. Coca-Cola Bottling Co. (GA Supreme Court, 1956) Intangibles Microsoft V. FTB, (San Francisco Superior Court Case No. CGC , 3/21/11, case appealed to the California Court of Appeals) Futures contracts General Mills v. FTB, (California Court of Appeals, 2009; remanded California Superior Court) 38

39 Application i To Single Sales S l Factor Single-sales factor facially constitutional Moorman Need to show the apportioned result is out of all proportion to the business transacted or has led to a grossly distorted result Colgate-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 sales state, would this ruling still hold? 39