Corporate Apportionment and Sourcing Rights in Multistate Tax Compact States Key Implications Triggered by California's Gillette Case

Transcription

1 Presenting a live 110-minute teleconference with interactive Q&A Corporate Apportionment and Sourcing Rights in Multistate Tax Compact States Key Implications Triggered by California's Gillette Case WEDNESDAY, JANUARY 23, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Bruce Ely, Partner, Bradley Arant Boult Cummings, Birmingham, Ala. Walter Pickhardt, Partner, Faegre Baker Daniels, Minneapolis Donald Griswold, Partner, Crowell & Moring, Washington, D.C. Jeremy Abrams, Attorney, Crowell & Moring, Washington, D.C. 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 Corporate Apportionment and Sourcing Rights in Multistate Tax Compact States Seminar Jan. 23, 2013 Jeremy Abrams, Crowell & Moring jabrams.crowell.com Don Griswold, Crowell & Moring Bruce Ely, Bradley Arant Boult Cummings Walter Pickhardt, Faegre Baker Daniels

6 Today s Program California's Gillette Case [Jeremy Abrams] Slide 8 Slide 24 Implications For Sourcing Revenue From Services, Intangibles [Don Griswold] Slide 25 Slide 41 Issues Arising From Other State Cases And Guidance [Bruce Ely] Slide 42 Slide 45 Practical Decisions Facing Multi-State Companies [Walter Pickhardt] Slide 46 Slide 72

7 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. 7

8 Jeremy Abrams, Crowell & Moring CALIFORNIA S GILLETTE CASE

9 The Gillette Company, et. al. v. California Franchise Tax Board I. Background A. Multistate Tax Compact (the Compact) B. California apportionment II. Discussion A. Procedural history B. The Court of Appeal s decision, on rehearing C. Pending Supreme Court review 9

10 Multistate Tax Compact: Brief History UDITPA Northwestern Cement P.L Willis Report Multistate Tax Commission 10

11 Multistate Tax Compact: Purpose Uniformity Equitable apportionment Taxpayer convenience 11

12 Multistate Tax Compact: Full Members Alabama, Alaska, Arkansas, California,* Colorado, District of Columbia, Hawaii, Idaho, Kansas, Michigan, Minnesota, Missouri, Montana, New Mexico, North Dakota, Oregon, South Dakota, Texas, Utah, Washington *California withdrew from the Compact effective June 27,

13 Multistate Tax Compact: Apportionment Formula Article IV, Sect. 9 All business income shall be apportioned to this State by multiplying the income by a fraction the numerator of which is the property factor plus the payroll factor plus the sales factor and the denominator of which is three. 13

14 Multistate Tax Compact: Taxpayer Election Article III, Sect. 1 Any taxpayer subject to an income tax whose income is subject to apportionment and allocation for tax purposes pursuant to the laws of a party State or pursuant to the laws of subdivisions in two or more party States may elect to apportion and allocate his income in the manner provided by the laws of such States or by the laws of such States and subdivisions without reference to this compact, or may elect to apportion and allocate in accordance with Article IV. 14

15 California Apportionment Adopted UDITPA in 1966 Uses its own numbering system Became signatory to Compact in 1974 Pre-1993 Dual apportionment statutes Cal. Rev. & Tax. Code 38006, art. IV, subd. 9 (Compact) Three factors, evenly weighted Cal. Rev. & Tax. Code (UDITPA) Three factors, evenly weighted 15

16 California Apportionment (Cont.) 1993 Amendment (switch to double-weighted sales) Cal. Rev. & Tax. Code 38006, art. IV, subd. 9 (Compact unchanged) Cal. Rev. & Tax. Code (double-weighted sales) Notwithstanding Section 38006, all business income shall be apportioned to this state by multiplying the income by a fraction, the numerator of which is the property factor plus the payroll factor plus twice the sales factor, and the denominator of which is four 16

17 Gillette v. FTB: Taxpayers The Gillette Co. and subs Procter & Gamble Manufacturing Co. Kimberly-Clark Worldwide, Inc. and subs Sigma-Aldrich, Inc. RB Holdings (USA) Inc. Jones Apparel Group, Inc. 17

18 Gillette v. FTB: Procedural History Refund claims denied Superior Court decision Court of Appeal s (first) decision Motion for rehearing 18

19 Gillette v. FTB: Issue [W]hether, for the tax years at issue since 1993, Taxpayers were entitled to elect the Compact formula, or, as respondent Franchise Tax Board (FTB) asserts, did the 1993 amendment to section repeal and supersede that formula, thereby making the state formula mandatory? 19

20 Gillette v. FTB: Decision On Rehearing (Oct. 2, 2012) Taxpayers have standing Refund claim for taxes paid pursuant to statute Third-party beneficiary of Compact 20

21 Gillette v. FTB: Decision On Rehearing (Cont.) Compact is binding on member states Indicia of an interstate compact Binding contract Valid state law State retains control over the tax base and rate. 21

22 Gillette v. FTB: Decision On Rehearing (Cont.) Cannot unilaterally repeal Compact provisions Compact supersedes subsequent, conflicting state statutes. States are prohibited from impairing obligations of contracts. FTB s construction would violate the state Constitution. 22

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24 Gillette v. FTB: Pending Supreme Court Review Nov. 13, 2012: FTB files petition for review Dec. 28, 2012: Court extends time for grant/denial to Feb. 11, 2013 Jan. 16, 2013: Court grants FTB s petition for review Stay tuned! 24

25 Don Griswold, Crowell & Moring IMPLICATIONS FOR SOURCING REVENUE FROM SERVICES, INTANGIBLES

26 To Apportionment And Beyond: Additional Refund Opportunities I. Statutory departures from Article IV provisions A. Apportionment formula B. Sourcing of sales other than sales of tangible personal property C. Business income definition D. Industry specific apportionment E. Other definitions II. Broader implications of Article IV? 26

27 Departures From Compact Apportionment Formula I. Double-weighted sales A. Alabama, Arkansas, California, District of Columbia, Idaho B. Example: All business income shall be apportioned to this state by multiplying the income by a fraction, the numerator of which is the property factor plus the payroll factor plus double the sales factor, and the denominator of which is four (4). Ark. Code Ann II. Shift to single-sales factor formula A. Colorado, Michigan, Minnesota, Oregon, Texas B. Example: All business income shall be apportioned to this state by multiplying the income by the sales factor. O.R.S

28 Departures From Sourcing Of Sales Other Than Sales Of Tangible Personal Property Compact rule: Greater costs of performance 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. Art. IV, Sect

29 Sales of services Market-Based Sourcing Location where service is delivered Alabama, Texas Example The taxpayer s market for a sale is in this state... In the case of sale of a service, if and to the extent the service is delivered to a location in this state. Ala. Code Sec Art. IV. Subd. 17.(a)(3). Location where benefit is received Minnesota, Utah Michigan Special rules for sales from securities brokerage services, transportation services, telecommunications services 29

30 Market-Based Sourcing (Cont.) Royalties from the use of patents, copyrights, etc. Where the intangible property is used by the purchaser Alabama, Colorado, Michigan, Minnesota, Utah Example where property used in more than one state If the property is used in more than one state, the royalties or other income must be apportioned to this state pro rata according to the portion of use in this state. If the portion of use in this state cannot be determined, the royalties or other income must be excluded from both the numerator and the denominator. Intangible property is used in this state if the purchaser uses the intangible property or the rights therein in the regular course of its business operations in this state, regardless of the location of the purchaser's customers. 30 Minn. Stat Subd. 5(h)

31 Pro rata cost of performance Other Sourcing Rules Colorado services performed within and outside of the state Unique rule 31 The portion of the gross receipt included in the Colorado numerator is found by multiplying the gross receipt by a fraction, the numerator of which is the direct costs incurred in the performance of that service in Colorado and the denominator of which is the direct costs incurred in the performance of that service everywhere. Colo. Code Regs (c) Arkansas - 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 within and without the state, in which event the portion of income allocable to this state shall be the percentage that is used in the formula for allocating income to Arkansas during the year of the sale. Ark. Code

32 Departures From Business Income Definition Compact definition Business income means 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. Art. IV, Sect. 1.(a) 32

33 Alabama Business Income Definition Notwithstanding any other provision of law to the contrary and specifically, Section , for purposes of Article IV of the Multistate Tax Compact, the term business income means [transactional test]; or income from tangible or intangible property if the acquisition, management, or [additional categories of income]. Ala. Code Sect District of Columbia Business income means all income that is apportionable under the Constitution of the United States. D.C. Code Sect (5) 33

34 Business Income Definition (Cont.) Idaho Business income means [transactional test] and includes income from the acquisition, management, or disposition of tangible and intangible property when such acquisition, management, or disposition constitutes integral or necessary parts of the taxpayer s trade or business operations. Gains or losses and dividend and interest income from stock and securities of any foreign or domestic corporation shall be presumed to be income from intangible property, the acquisition, management, or disposition of which constitutes an integral part of the taxpayer s trade or business; such presumption may only be overcome by clear and convincing evidence to the contrary. Idaho Code

35 Business Income Definition (Cont.) New Mexico Business income means 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 constitute integral parts of the taxpayer's regular trade or business operations. N.M. Stat. Ann Oregon Business income means 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, the management, use or rental, and the disposition of the property constitute integral parts of the taxpayer s regular trade or business operations. O.R.S

36 Departures From Industry Specific Apportionment No industry specific formulae in the Compact except exclusion of financial organizations and public utilities If a taxpayer has income from business activity as a public utility but derives the greater percentage of its income from activities subject to Article IV, then the taxpayer may elect to allocate and apportion its entire net income as provided in Article IV. 36

37 Industry Specific Apportionment California franchisors 37 Following receipts attributed to the state in which the franchisee s place of business is situated, provided the taxpayer is taxable in such state Advertising fees, administrative/advisory services fees, site acquisition fees If the taxpayer is not taxable in the state in which the franchisee s place of business is, or would have been, located, the receipts shall be attributed to the state in which the principal office of the taxpayer s employee or employees performing such services is located, except that if such services are performed by an independent contractor the receipts shall be attributed to the state of the taxpayer s commercial domicile. Cal. Code Regs

38 Industry Specific Apportionment (Cont.) Manufacturing Print media Broadcasting Shipping Telecommunications 38

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40 Sales Departures From Other Article IV Definitions All gross receipts of the taxpayer not allocated under paragraphs of this Article Compensation Wages, salaries, commissions and any other form of remunerations paid to employees for personal services 40

41 Broader Implications Of Article IV? 41

42 Bruce Ely, Bradley Arant Boult Cummings ISSUES ARISING FROM OTHER STATE CASES, GUIDANCE

43 Issues With Other State Cases And Administrative Guidance On Similar Issues A. With California s withdrawal, 18 states plus D.C. remain full members of the Compact. At least 10 of those states have apportionment provisions that differ from UDITPA, e.g., a single sales factor. B. International Business Machines Corp. v. Michigan Dept. of Treasury, Dkt. No (Mich. Ct. App. 11/20/12, unpublished); motion for leave to appeal to Mich. S. Ct. pending; motion to admit Gillette attorneys pro hac vice also pending C. Health Net, Inc. v. Oregon Dept. of Revenue, Dkt. No D (pending in Oregon Tax Court) 43

44 Issues With Other State Cases And Administrative Guidance On Similar Issues (Cont.) D. Announcement, Oregon Dept. of Revenue, (last visited 1/16/13) E. Graphic Packaging Corp. v. Comptroller, Dkt. No. GN (pending in Travis Co. Dist. Ct.) D. Texas Comptroller of Public Accounts, Hearing Decision Nos. 106,508 (7/13/12) and 104,752 (8/18/11) E. Multistate Tax Commission statements/positions F. Council On State Taxation (COST) responses 44

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46 Walter Pickhardt, Faegre Baker Daniels PRACTICAL DECISIONS FACING MULTI-STATE COMPANIES

47 Pending Litigation In MTC States Health Net IBM Gillette Graphic Packaging 47

48 Other MTC States Where Litigation May Arise Litigation may also arise in the following MTC states, because they do not follow the Compact s three-factor, equal-weighted apportionment formula. 48

49 CALIFORNIA 49

50 California: SB 1015 After oral argument in Gillette, but prior to the decision, the California Legislature enacted SB 1015, which Gov. Brown signed on June 27, SB 1015 repealed the Multistate Tax Compact. The repeal of the Compact left standing the California three-factor formula that double-weights the sales factor. SB 1015 enacted the doctrine of election (citing federal law), and said it was declaratory of existing California law. SB 1015 may not be constitutional. Under Proposition 26, any change in state statute which results in any taxpayer paying a higher tax must pass by a two-thirds vote. SB 1015 was passed without a two-thirds vote. 50

51 The Federal Doctrine Of Election The doctrine of election is a not-often-cited, federal equitable doctrine whose continuing validity has been questioned. See 62 Tax Lawyer 335 The doctrine consists of the following two elements: (1) There must be a free choice between two or more alternatives, and (2) There must be an overt act by the taxpayer communicating the choice to the taxing authority. See Grynberg v. Commissioner, 83 TC 255 (1984); see also Pacific National Co. v. Welch, 304 U.S. 191 (1938) The doctrine is not common in state tax cases, but there are some California cases applying the doctrine. 51

52 California s Position On The Doctrine Of Election California s position is that taxpayers that filed original returns using California s weighted (or single-factor) formula made a binding election and cannot later file amended returns to change that election to the MTC formula. See FTB Tax News (Oct. 5, 2012) and FTB Notice (October 5, 2012) A counter-argument would be that California has consistently denied that an MTC election is available, so the taxpayer was not given a free choice. Another counter-argument would be that California s threat of imposing substantial penalties for using the MTC formula on a return filed before the due date deprived taxpayers of a free choice. Yet another counter-argument would be that a party must have clean hands to invoke equitable doctrines. The above facts indicate a lack of clean hands. 52

53 California s Large Corporation Understatement Penalty (LCUP) California imposes a 20% penalty on understatements of tax exceeding the greater of (1) $1 million, or (2) 20% of the tax shown on an original return or shown on an amended return filed on or before the original or extended due date of the return for the taxable year. This is a strict liability penalty. There is no abatement, even for reasonable cause. However, no penalty is imposed if an understatement is attributable to a change in law that occurs after: The date the taxpayer files the return for the taxable year for which the change is operative. The extended due date for the return of the taxpayer for the taxable year for which the change is operative. 53

54 California s Position On The LCUP For 2011 Returns Returns for calendar 2011 were due Oct. 15, 2012, after Gillette had been decided but before it technically became final. California announced that taxpayers filing returns relying on Gillette would be subject to the LCUP. if the case were later reversed. Taxpayers were put between a rock and a hard place. File based on Gillette and risk the LCUP if Gillette were reversed; or Don t file based on Gillette, file amended returns and face the argument that they made a binding election to use weighted apportionment 54

55 California Proposition 39 In November 2012, the California voters approved a ballot initiative, Proposition 39. Proposition 39 requires multi-state corporations (with some exceptions) to use a single-factor apportionment formula with market-based sourcing, for sales of services and intangibles. Proposition 39 is effective for tax years beginning on or after Jan. 1,

56 California Apportionment Through 2012 The apportionment options for years through 2012 are: Three-factor, double-weighted sales factor Single sales factor with market-based sourcing MTC three-factor (equal-weighted) apportionment, if Gillette is affirmed 56

57 California Apportionment 2013 If SB 1015 is unconstitutional, then the apportionment options are: Single sales factor, pursuant to Proposition 39 MTC apportionment, if Gillette is affirmed If SB 1015 is constitutional, then the only apportionment option is: Single sales factor, pursuant to Proposition 39 57

58 California Taxpayer Options Through 2011 Tax Year: Original Returns Some taxpayers may have filed returns using MTC apportionment during If Gillette is reversed, there is a possibility of the LCUP applying. A counter-argument would be that the LCUP does not apply when there is a change of law after the date the taxpayer files the return. But, California may argue that Gillette was not the law until after the Court of Appeals decision on hearing (Oct. 12, 2012) became final 30 days later (Nov. 1, 2012). 58

59 California Taxpayer Options Through 2011 Tax Year: Amended Returns Should taxpayers now file amended returns to use MTC apportionment? Filing a refund claim now should not implicate the LCUP, as the penalty applies for refunds shown on amended returns filed on or before the original or extended due date of the return for the taxable year. California allows protective claims. They should be prepared following the procedures in FTB Notice (Oct. 2, 2012). No action will be taken on such claims until after Gillette is resolved. Despite allowing protective refund claims, California can be expected to argue that the taxpayer is bound by the apportionment method elected on the original return, under the doctrine of election. There are counter-arguments to the doctrine of election, including (1) that it is inapplicable (SB 1015 is unconstitutional) and (2) that the doctrine applies only when the taxpayer has free choice between two or more alternatives. That was not the case here (especially given the threat of the LCUP). 59

60 California Taxpayer Options For 2012 And 2013: Original Returns Should a taxpayer file an original return using MTC apportionment? The risk is that MTC apportionment will not be available if either (1) SB 1015 is constitutional (because it revoked MTC apportionment), or (2) Gillette is overturned (because then MTC apportionment was never available). If SB 1015 is constitutional, California will probably penalize the taxpayer using the LCUP. If the Court of Appeals decision in Gillette is still the law when the original return is filed, and subsequently Gillette is reversed, the change-in-law defense to the LCUP may be applicable. 60

61 California Taxpayer Options For 2012 And 2013: Amended Returns Should a taxpayer file an original return using Proposition 39 apportionment and file a protective claim using MTC apportionment? The LCUP does not apply for refunds shown on amended returns filed after the original or extended due date of the return for the taxable year. Protective claims may be filed following the procedures in FTB Notice (Oct. 2, 2012). However, California will likely argue that the taxpayer is bound by the apportionment method elected on the original return under the doctrine of election. So, a taxpayer taking this route will need to defeat the doctrine of election argument. As the situation is constantly evolving, taxpayers will need to monitor developments. 61

62 OREGON 62

63 Oregon: Doctrine Of Election Oregon case law has recognized the doctrine of election. It would not be surprising if Oregon were to argue that a taxpayer not making the election to use MTC apportionment on its original return is precluded from doing so by the doctrine of election. However, in one case, the Tax Court refused to apply the doctrine when the tax form did not provide sufficient information to apprise the taxpayer that the election could be made. See Uniroyal, Inc. v. Department of Revenue, 5 Or. Tax 29 (1972) 63

64 Oregon: Amended Returns Oregon has advised taxpayers to file protective refund claims to secure the right to a refund, should the state lose in litigation similar to Gillette. The release provides that claims may be either in the form of an amended return or a letter to the Revenue Department. For details on how to prepare the filing, see the department s news release dated Sept. 24, Oregon might assert the doctrine of election, even though its news release does not mention it. This is an unavoidable risk for prior years. If an original return can be filed, taxpayers may want to claim MTC apportionment on an original return. 64

65 Oregon: Original Returns Should taxpayers file original returns claiming MTC apportionment? There is a risk that the substantial understatement penalty could apply. However, the penalty can be avoided if there is substantial authority for the position, or if the relevant facts are adequately disclosed in the return and the position has a reasonable basis. It would seem that that there is a reasonable basis for MTC apportionment and that disclosure of the position should be enough to preclude the Revenue Department from imposing the penalty, but there can be no assurances. 65

66 MICHIGAN 66

67 Michigan: 2011 P.A. 40 The Michigan Legislature, in an attempt to foreclose future apportionment using the MTC three-factor, equal-weighted formula, enacted 2011 P.A. 40, which was signed by the governor on May 25, The law states that beginning Jan. 1, 2011 any taxpayer subject to the Michigan Business Tax act, or the income tax act of 1967, shall, for purposes of that act, apportion and allocate in accordance with the provisions of that act and shall not use MTC apportionment. Michigan imposed its Michigan Business Tax (MBT) beginning in 2008, the year at issue in IBM. Michigan replaced the MBT with a corporate income tax (CIT) in 2011, the same year it repealed the MTC formula. Although Michigan repealed the MTC formula, Michigan remained a member of the MTC. If Gillette is correct, a member of the MTC is bound under Compact law to allow an election of the MTC formula unless it completely withdraws from the Compact by enacting a statute repealing the Compact. 67

68 Michigan: Amended Returns IBM has lost in the Michigan Court of Appeals, but it filed an application for leave to appeal with the state Supreme Court on Dec. 28, Michigan advised the Court of Appeals that there are more than 100 pending cases similar to IBM. Taxpayers may want to file amended returns to protect their rights to a refund, in the event the IBM case is reversed or another taxpayer is successful. The Michigan Treasury Department has not provided guidance on filing protective claims. There does not appear to be any Michigan case law addressing the doctrine of election. The Treasury Department has not provided guidance on whether it would claim the doctrine of election applies, but if IBM were to be overturned, it would not be surprising if Michigan were to make such an argument. 68

69 Michigan: Original Returns Should a taxpayer file an original return using MTC apportionment? The benefit is that using MTC apportionment on an original return eliminates the possible argument based on the doctrine of election. There is a risk that the Treasury Department might impose the negligence penalty, but it can be abated for reasonable cause. 69

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71 TEXAS 71

72 Texas Original Or Amended Return? Texas has relatively light penalties. A penalty of 5% of the tax due is imposed on an entity that fails to pay the tax when due. An additional 5% penalty is imposed if the entity fails to pay the tax within 30 days after the due date. A taxpayer therefore could take the position on an original return without significant penalty exposure. However, an amended return is also a possibility, because Texas does not appear to have any authority applying the doctrine of election. 72