Presenting a live 110-minute teleconference with interactive Q&A. Today s faculty features:

Transcription

1 Presenting a live 110-minute teleconference with interactive Q&A Advanced Apportionment Issues Confronting Multi-State Companies Reporting Accurately and Strategically, Preparing for Problematic States, and Avoiding Potentially Costly Apportionment Errors TUESDAY, OCTOBER 8, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Mark Nachbar, Principal, Ryan, Downers Grove, Ill. Gary Bingel, Partner, EisnerAmper, Iselin, N.J. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

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5 Advanced Apportionment Issues Confronting Multi-State Companies Seminar Oct. 8, 2013 Mark Nachbar, Ryan Gary Bingel, EisnerAmper

6 Today s Program Sourcing Of Income From Services And Intangibles [Mark Nachbar] Impact Of California Gillette Case Elsewhere [Mark Nachbar] Alternative Apportionment Requests [Mark Nachbar] Destination Sales [Mark Nachbar] State Challenges To Joyce Positions [Gary Bingel] Throwback/Throwout: Common Issues [Gary Bingel] Foreign Sales Income And Throwback/Throwout [Gary Bingel] Economic Nexus Impact On Throwback/Throwout [Gary Bingel] Other PTE Apportionment Issues [Gary Bingel] Slide 8 Slide 14 Slide 15 Slide 21 Slide 22 Slide 35 Slide 36 Slide 39 Slide 40 Slide 43 Slide 44 Slide 53 Slide 54 Slide 58 Slide 59 Slide 61 Slide 62 Slide 71

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 Mark Nachbar, Ryan LLC SOURCING OF SALES FROM SERVICES AND INTANGIBLES

9 Sourcing Of Receipts From The Sale Of Non-Tangible Property Cost of performance Receipts from the sales of other than tangible personal property UDITPA Sect. 17 Has been adopted by a majority of states Provides sales of tangible personal property are in a state if: Income producing activity is in the state, or A greater proportion of income producing is in the state. Sect. 17 prescribes the preponderance method. Alternative cost of performance measurements Majority of costs 9 Proportionate method

10 Sourcing Of Receipts From The Sale Of Non-Tangible Property (Cont.) Basic issues What is an income-producing activity? At what level is it determined? What are direct costs? What costs are actually included? Administrative costs Third-party costs Independent contractors South Carolina PLR 133 (8/7/13) On the behalf rule Costs from other members of the unitary group 10

11 Sourcing Of Receipts From The Sale Of Non-Tangible Property (Cont.) Market-based sourcing Shift to market-based sourcing A number of states have changed their sales factor sourcing rules, shifting from a cost of performance approach to adopt market-based sourcing regimes for services and intangibles receipts. Rationale for the shift The complexity of sourcing receipts from non-tangible property Administrative burden on all parties to determine cost of performance components Aimed at attributing revenue to the state-based market (i.e., state) that contributes to taxpayer s income. If a pure market-sourcing approach applied, then the taxpayer s costs of performance would not be considered. 11

12 Sourcing Of Receipts From The Sale Of Non-Tangible Property (Cont.) 12 Alternative methods for defining the market Where benefit of services is received by customers Where services are performed Where intangibles are used Where the customers are situated Where benefit of services is received issues and approaches Generally, benefit is received at the customer location. Benefits received in more than one state Individual customers vs. business customers Order location vs. billing location Benefit location is indeterminable. No nexus or fixed place of business in benefit location AL Reg. Sec , (3/29/13, eff. 4/9/13)

13 Sourcing Of Receipts From The Sale Of Non-Tangible Property (Cont.) 13 Where services are performed Focuses on taxpayer s activities in performing the services. Is this the true market? Issues Possible application of market approach by states regardless of where services are performed rule Services performed in more than one state Location where services performed is not readily determinable Ameritech Publishing (WI) AT&T(MA and OR) Michinana Metronet Inc., v. Michigan Dept. of Treasury, (MI Ct of App, No , 11/8/12)

14 Sourcing Of Receipts From The Sale Of Non-Tangible Property (Cont.) Receipts from intangibles Sourcing receipts derived from the sale or license of intangible property is difficult because intangibles, by their nature, do not have a definite geographical locations. Receipts are derived from intangibles through the following transactions: Sales of intangibles Licensing of intangibles in exchange for royalties Where intangibles are utilized issues Where utilized by payor (e.g., licensee) Is utilization where licensee is located? Where licensee manufactures product? Where licensee sells product? What if location of utilization cannot be determined? What if taxpayer/licensor not taxable where intangibles utilized? 14

15 Mark Nachbar, Ryan LLC IMPACT OF CALIFORNIA GILLETTE CASE ELSEWHERE

16 Apportionment: MTC Article III Trend to more heavily weighted sales factor or single-sales factor formula Only eight of 19 MTC member states continue to use the equally weighted three-factor apportionment formula. MTC Article III obligates member states to offer their multi-state taxpayers the option of using either the Compact s three-factor formula to apportion and allocate income for state income tax purposes or the state s own alternative apportionment formula. California withdrew from the MTC on June 27, 2012 in anticipation of the decision in Gillette vs. FTB. Other state withdrawals/reinactments: OR, UT, DC, MN (considering) Is this valid? 16

17 Apportionment: MTC Article III (Cont.) A California taxpayer was permitted to use the equally weighted three-factor MTC apportionment formula to calculate its California franchise tax. Gillette argued that the state s mandate of apportionment using double-weighted sales factor violated California s participation in the MTC. The California Court of Appeals determined that the Multistate Tax Compact is binding on the signatory states and that it calls for the option, under UDITPA, to apportion income on a equally weighted three-factor basis. The election is necessary to provide a taxpayer an option for uniformity when there are conflicting state statutes. The only way for a member state to eliminate this option is to withdraw from the MTC. Gillette Co. v. Franchise Tax Board, No. A130803, Court of Appeal of California, First District (Oct. 2, 2012) CA Supreme Court has accepted, and the case is fully briefed. 17

18 Apportionment: MTC Article III (Cont.) IBM v. Michigan Dept. of Treasury (MI Ct. of App., unpublished decision, 10/20/12) Compact is not a binding contract under MI law. On appeal to the MI Supreme Court. Anhueser Bush v. Michigan Dept. of Treasury ( MI Ct of Claims, published decision, 6/6/13) Considered MBT in two parts: modified gross receipts portion is not an income tax, and not subject to the MTC election; can use 3 factor treatment for business income tax base Supreme Court would not consider under direct appeal Lorilard Tobacco v. Michigan Dept. of Treasury Fully briefed for court of claims Brief on income tax base 18

19 Apportionment: MTC Article III (Cont.) In an Oregon Tax Court case, an out-of-state taxpayer is asserting that it has a right to elect to apportion its income under the Multistate Tax Compact s evenly weighted three-factor formula. The complaint to the tax court s magistrate division was filed on July 2. The parties met in a case management conference in August, and on Sept. 17 filed for a petition of special designation to bypass the magistrate division and start the proceedings in the regular division. That petition is awaiting a ruling by the judge. Oregon adopted the compact in 1967 and is still a full member. However, in 1993, the state enacted Revised Statute , which says that when Oregon enacts an apportionment formula that conflicts with the Multistate Tax Compact election provision, the state statute is controlling. Oregon currently requires single-sales-factor apportionment. Health Net, Incorporated and Subsidiaries v. Department of Revenue (Case No D) 19

20 Apportionment: MTC Article III (Cont.) In orders released by the Texas Controller of Public Accounts on 9/12/12, 5/16/13, 6/18/13 and 8/14/13, denied the refund claims of three unidentified out-of-state businesses that attempted to elect to apportion their income under the Multistate Tax Compact s evenly weighted threefactor formula. In the 6/18/13 case the taxpayer introduced the CA Gillette win into the record. The Comptroller ruled that no weight can be given to Gillette as it was depublished, and cert was granted by the California Supreme Court. Texas adopted the Multistate Tax Compact in 1967 and is still a full member, with the compact codified as chapter 141 of the Texas Tax Code. However, Sect (a) of the Code requires that a taxable entity s margin be apportioned to Texas under a single-factor formula based on gross receipts. Texas is a bit more complex than California, as there is a question as to whether the Texas gross margins tax is an income tax. 20

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22 Mark Nachbar, Ryan LLC ALTERNATIVE APPORTIONMENT REQUESTS

23 Alternative Apportionment The standard alternative apportionment provision is found in UDITPA 18. If the allocation and apportionment provisions of this Act do not fairly represent the extent of the taxpayer s business activity in this state, the taxpayer may petition for or the [tax administrator] may require alternative apportionment. Under UDITPA, the burden of proof is on the party (state tax authority or taxpayer) seeking to diverge from the standard apportionment formula to prove that distortion exists, and that a proposed alternative method is reasonable. 23

24 Invoking Alternative Apportionment Many states have either adopted UDITPA or similar language granting them the authority to use an alternative apportionment method. When a state or taxpayer wants to use an alternative apportionment method, they carry the burden of proof in showing: Distortion exists, and That a proposed alternative method is reasonable. Example: In Microsoft Corp. v. Franchise Tax Board, the California Supreme Court stated: As the party invoking section 25137, the Board has the burden of proving by clear and convincing evidence that (1) the approximation provided by the standard formula is not a fair representation, and (2) its proposed alternative is reasonable. 139 P.3d 1169, 1178 (Cal. 2006) (emphasis added) 24

25 Invoking Alternative Apportionment (Cont.) Burden of proof What standard of proof must be met for a taxpayer or state to prove distortion? Clear and convincing evidence Somewhere between preponderance of evidence and beyond a reasonable doubt Example: California Microsoft v. Franchise Tax Board, 139 P.3d 1169 (Cal. 2006). Clear and cogent evidence Example: New York Must demonstrate by clear and cogent evidence that the standard apportionment formula does not properly reflect a taxpayer s presence. British Land (Maryland) Inc. v. N.Y. Tax App. Trib., 85 N.Y.2d 139, (N.Y. Ct. App. 1995) Prima facie evidence 25

26 Invoking Alternative Apportionment: Distortion What level of distortion must be shown in order for a taxpayer or state to be entitled to alternative apportionment? Constitutional gross distortion Twentieth Century-Fox Films v. Dep t of Revenue, 700 P.2d 1035 (Ore. 1985) Oregon Supreme Court reviewed whether the department proved that the statutory three-factor apportionment formula did not fairly represent the extent of taxpayer s business activity in this state, thus permitting the department to employ a different method. Court held that alternative apportionment is only applicable to remedy unconstitutional situations or when the UDITPA formula does not fairly represent the business activity of the taxpayer. Florida and Illinois regulations provide if the statutory formula will lead to grossly distorted results in a particular case, a fair and accurate alternative method is appropriate. Fla. Admin. Code Ann. 12C ; 86 Ill. Admin. Code (c) 26

27 Invoking Alternative Apportionment: Distortion (Cont.) Most states have found that the constitutional gross distortion requirement is not necessary to justify alternative apportionment some lesser standard usually applies. Consistent with Sect. 18, many states require only a showing that the statutory formula does not fairly reflect the extent of the taxpayer s activities in the state. 27

28 Invoking Alternative Apportionment: Distortion (Cont.) Illinois regulations provide: A departure from the required apportionment method is allowed only where such methods do not accurately and fairly reflect business activity in Illinois. An alternative apportionment method may not be invoked, either by the director or by a taxpayer, merely because it reaches a different apportionment percentage than the required statutory formula. However, if the application of the statutory formula will lead to a grossly distorted result in a particular case, a fair and accurate alternative method is appropriate. 86 Ill. Adm. Code (c) Illinois General Information Letter No. IT GIL (June 20, 2011) An investment company that invested substantially all of its net assets in a portfolio of master limited partnerships requested that the apportionment factors of the underlying partnerships be used as an alternative apportionment method for its gain from sales of partnership interests. Department determined there is nothing inherently distortive or unfair in sourcing gross receipts from sales of partnership interests, based on the activities of the partner in managing its investment in the partnership. 28

29 Invoking Alternative Apportionment: Distortion (Cont.) California uses qualitative and quantitative analyses to determine if distortion exists. Qualitatively different The qualitative analysis examines the type of business conducted by the taxpayer in comparison to any activity that may create distortion. Quantitative distortion Quantitative distortion may be demonstrated by various methods including separate accounting, comparison of profit margins, comparison of apportionment percentages, comparison of income and gross receipts from various activities, etc. Profit margin from a taxpayer s primary business is several orders of magnitude different from the profit margin on the treasury function. Courts in Microsoft and Square D found distortion where operational profit margin far exceeded treasury profit margin. Microsoft: Operational margin 167x greater than treasury profit margin. Square D: Operational margin 74x greater than treasury profit margin. 29

30 Invoking Alternative Apportionment: Distortion (Cont.) Fla. Tech. Asst. Adv. No. 08C1-006 (July 25, 2008) Illustrates the difficulty in obtaining alternative apportionment Taxpayer requested alternative apportionment formula because it pays an income tax on over 150% of its federal consolidated income. Department denied request and noted that the fact taxpayer was filing on different bases contributed to why the taxpayer paid tax on more than 100%. The taxpayer reaped the benefit of including affiliated group in apportionment factors. 30

31 Invoking Alternative Apportionment: Distortion (Cont.) BellSouth Adv. & Pub. Co. v. Chumley, 308 S.W.3d 350 (Tenn. Ct. App. 2009), appeal denied (March 1, 2010) 31 Court held that the commissioner could apply alternative apportionment formula. Taxpayer sourced receipts in accordance with statute using cost of performance (i.e., receipts sourced to Tennessee if a majority of taxpayer s income-producing activity occurs in Tennessee). Commissioner invoked an alternative apportionment formula and required the taxpayer to use market sourcing rules. Court held that the commissioner established that the statutory formula did not adequately represent the taxpayer s business activity in the state, based solely on the fact that BellSouth generated substantial revenue from the distribution of advertising within the state. Court granted commissioner wide latitude to disregard the statutory formula in any case in which the commissioner believes Tennessee should be entitled to greater tax revenue, as opposed to extraordinary and unique circumstances.

32 Invoking Alternative Apportionment: Distortion Cont.) While BAPCO s all or nothing argument is appealing, in that the commissioner can virtually ignore the statutorily required cost of performance formula when the results are unfavorable to the Department, the fact remains that Tenn. Code Ann (a) and (a) were enacted by the legislature to provide the commissioner with the authority to permit or require a departure from the standard apportionment formula, when application of the formula does not fairly represent the extent of the taxpayer s business activity in Tennessee and the commissioner is given the authority to use any method to source receipts for purposes of the receipts factor or factors of the apportionment formula numerator or numerators. 32

33 Invoking Alternative Apportionment: Reasonable Alternative Carmax Auto Superstores West Coast, Inc. v. S.C. Dep t of Revenue, Op. No (S.C. Ct. App. March 14, 2012) The court concluded that the department bears the burden to prove both that the statutory formula does not fairly represent CarMax West s business activity in South Carolina, and that the Department s alternative accounting method is reasonable and more fairly represents CarMax West s business activity in South Carolina. The court remanded the case to the ALC. 33

34 Invoking Alternative Apportionment (Cont.) Taxpayers, however, should consider asserting alternative apportionment where appropriate. 34 Media General, Inc. et al. v. S.C. Dep t of Revenue, 694 S.E.2d 525 (S. Car. 2010) The Department need not automatically use the method requested by the taxpayer as it has the discretion to select an alternative method that fairly measures the taxpayer's income in South Carolina. Upheld taxpayer s assertion of alternative apportionment using combined filing method, when state stipulated to fact that separate filing resulted in distortion

35 Recent Developments in Alternative Apportionment Equifax Inc. v. MS Dept. of Rev., MS, No CT SCT, 6/20/13 Equifax had 3 employees in MS and 800 customers Under cost of performance methodology taxpayer apportioned $0 in income to MS MS Commissioner recalculated tax based on market state rules resulting in an in state income of $22M Supreme Court sided with Commissioner stating that the COP rules did not accurately reflect the taxpayers presence in the state, and that the use of a market state rule was an alternative apportionment methodology Moreover the Court placed the burden of proof on the taxpayer to prove that the alternative method did not properly reflect its presence in the state. 35

36 Mark Nachbar, Ryan LLC DESTINATION SOURCING

37 Destination Sourcing Sales of tangible personal property are in this state if: (a) The property is delivered or shipped to a purchaser, other than the United States government, within this state regardless of the f. o. b. point or other conditions of the sale (UDITPA Art. IV Sect. 16) Generally means where the buyer obtained possession or control of the goods However the application of Sect. 16 is unclear in the case of dock sales Place of delivery, or Ultimate destination State courts have ruled that dock sales should be assigned to the purchasers location within this state refers to purchaser The intended purpose of the sales factor is to measure the customer base within a state 37

38 Destination Sourcing (Cont.) Department of Revenue v. Parker Banana, 391 So. 2d 762, FL 1980 Involved the sale of bananas which were picked up in Florida by out of state purchasers McDonnell Douglas Corp., v FTB 26 Cal. App. 4 th 1789, 7/7/94 Customer picks up aircraft from a facility located in CA, and transports the aircraft to an out of state location Indiana Dept of Revenue v. Miller Brewing Co., Indiana Supreme Court Docket Number 49S TA /26/12 Sales of beer to Indiana distributors, picked up by the distributor at an Ohio brewery, and brought into Indiana were Indiana sales Virginia PLR , 10/23/12 Intercompany sales to an instate affiliate, held by the affiliate in VA prior to the shipment out of state, were VA sales 38

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40 Gary Bingel, EisnerAmper JOYCE / FINNIGAN POSITIONS

41 Joyce vs. Finnigan Sales of tangible personal property are in this state if: (b) 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. Joyce: Taxpayer means particular entity making the sale. Finnigan: Taxpayer means the combined group. Joyce example: Texas receipts include the gross receipts of each taxable entity that is a member of the combined group and that has a nexus with this state for the purpose of taxation. (TX Tax Code Sect ) Finnigan example: In Wisconsin, a taxpayer is considered to be within the jurisdiction for income or franchise tax purposes of any state in which any member of its combined group is within the jurisdiction for income or franchise tax purposes. (Wis. Statute Sect (5)(a)(8)) 41

42 Major Joyce And Finnigan States Joyce Finnigan Colorado Alaska Illinois California (2011) Montana Indiana Nebraska Kansas New Hampshire Maine North Dakota Massachusetts Texas Michigan Virginia New York West Virginia Wisconsin 42

43 Joyce / Finnigan Nexus Controversies Texas receipts include the gross receipts of each taxable entity that is a member of the combined group and that has a nexus with this state for the purpose of taxation. (TX Tax Code Sect ) MTC statement: Activities that are conducted by any other person or business entity, whether or not said person or business entity is affiliated with said company, shall not be considered attributable to said company, unless such other person or business entity was acting in a representative capacity on behalf of said company. What nexus standard applies? Physical presence (Quill v. N. Dakota) P.L (in-state solicitation protected) Economic presence? Factor presence? 43

44 Joyce / Finnigan PTE Issues Even in separate reporting jurisdictions there may be Joyce / Finnigan-type issues where Pass-Through Entities ( PTE s ) are involved. Specifically, at what level does nexus and/or the sales factor get determined? At the PTE level or at the partner / member level? Does PL protection pass-through to the partner / member? AZ PL protection doesn t flow-up to owners of PTE s. Factors of otherwise protected PTE are included in numerator of owner subject to AZ taxation. AZ Dept. of Rev. V. Central Newspapers, Inc., AZ CT. App, Div. 1, 218 P3d 1083 (11/3/09). Arizona is a Finnigan state and this decision is consistent with Finnigan. Although Arizona is a combined state, this reasoning applies equally to stand-alone corporations with an interest in a PTE. 44

45 Joyce / Finnigan PTE Issues What about states that directly tax various PTE s / DE s? E.g., Texas? Companies often overlook the Joyce / Finnigan impacts on otherwise disregarded entities. Assume a stand-alone corporation with a SMLLC subsidiary. The parent corporation has Texas nexus, but the SMLLC does not, although it does have significant sales into Texas. Since Texas is a Joyce state, and the SMLLC does not have nexus, you should not include the sales of the SMLLC in the combined Texas receipts factor. Many companies overlook this, especially where PTE s and combined reporting is involved. 45

46 Gary Bingel, EisnerAmper THROWBACK/THROWOUT: COMMON ISSUES

47 Throwback Rule Under UDITPA, sales of tangible personal property (TPP) are included in the numerator of the sales factor if either: The property is delivered or shipped to a purchaser (other than the U.S. government) within the state, or The property is shipped from a location in the state and (1) the purchaser is the U.S. government, or (2) the taxpayer is not taxable in the state of the purchaser. The second clause is known as the throwback rule. Sales that would otherwise be included in the numerator of another state s sales factor are thrown back to the state of origination, if the taxpayer is not taxable in the state of the purchaser. Has the effect of increasing the numerator of the state s sales factor, with no effect on the denominator causing the sales factor (and thus, the apportionment factor) to increase. 47

48 Throwback Rule: Common Issues The phrase taxable in the state of the purchaser is not defined in UDITPA. However, another section of UDITPA (relating to whether the taxpayer has the right to apportion) provides that a taxpayer is taxable in another state if: (1) In that state, it is subject to a net income tax, a franchise tax measured by net income, a franchise tax for the privilege of doing business, or a corporate stock tax; or (2) that state has jurisdiction to subject the taxpayer to a net income tax regardless of whether, in fact, the state does or does not. Some common circumstances in which a state might attempt to require throwback: The taxpayer does not have nexus with the destination state. The taxpayer is protected by P.L in the destination state. The destination state does not impose an income tax or franchise tax. The taxpayer does not actually file an income or franchise tax return in the destination state. 48

49 Throwback Rule: Common Issues (Cont.) Application of Joyce/Finnigan rules in the context of throwback 49 Recall, in the inbound context: Sales by a combined group member into a Joyce state, when the member does not have nexus or is P.L protected in that state, are excluded from the combined group s sales factor in the state. Sales by a combined group member into a Finnigan state, when the member does not have nexus or is P.L protected in that state, are included in the combined group s sales factor in the state. But, in the outbound context, when the origination state has a throwback rule: Sales by a combined group member from a Joyce state destined for a state in which the member does not have nexus or is P.L protected are thrown back and are included in the combined group s sales factor in the state. Sales by a combined group member from a Finnigan state destined for a state in which the member does not have nexus or is P.L protected are thrown back and are excluded from the combined group s sales factor in the state.

50 Throwback Rule: Common Issues (Cont.) 50 Application of Joyce/Finnigan rules in the context of throwback May cause perceived under-inclusion or over-inclusion of sales Sales of TPP made by a combined group member from a Joyce state that has a throwback rule into a Finnigan state in which another group member is taxable will be included in the combined group s sales factor numerator in both states. Potentially beneficial to create a taxable presence in the Finnigan state by the entity in the Joyce state, which would cause the throwback rule to not apply Sales of TPP made by a combined group member from a Finnigan state that has a throwback rule into a Joyce state in which another group member is taxable will be excluded from the combined group s sales factor numerator in both states.

51 Throwout Rule: Whirlpool Whirlpool v. Div. of Taxation (N.J., July 28, 2011) The taxpayer argued that New Jersey s throwout rule was facially unconstitutional. New Jersey Supreme Court held the throwout rule was not facially unconstitutional as applied to receipts attributed to states in which the taxpayer was not subject to tax by virtue of P.L or did not have requisite contacts to establish nexus. However, the throwout rule did not operate permissibly with respect to receipts attributed to states that choose not to impose a business activity tax. Court determined the Legislature intended rule to be applied narrowly; thus, the rule was not unconstitutional on its face. 51

52 Sales Factor: Throwback/Throwout Rules Sales Of TPP (2012) MA Unique throwback rule based on sales office NJ Throwout repealed beginning for periods on or after July 1, 2010 No Tax No throwback or throw-out Throwback (DC, RI) Throwback/Double Throwback (AK, HI) Throw-out TX Throwback rule for the former franchise tax; no throwback rule under revised franchise tax KY & TN Throwback for sales to U.S. govt. only MO Throwback only applies for purposes of the three-factor formula; there is no throwback for single factor formula. 52

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54 Gary Bingel, EisnerAmper FOREIGN SALES INCOME AND THROWBACK/THROWOUT

55 Throwback/Throwout: Foreign Sales How does a taxpayer apply a throwback or throwout rule, when a sale is made into a foreign country? Note that UDITPA s definition of state includes foreign countries. Accordingly, sales into a foreign country may be thrown back if both (1) the taxpayer is not subject to tax in the foreign country, and (2) the foreign country does not have jurisdiction to tax the taxpayer. One of the more difficult questions: How does a taxpayer determine whether the foreign country has jurisdiction to tax the taxpayer? Apply U.S. jurisdictional principles? Apply jurisdictional principles of the foreign country? How does an income tax treaty affect the analysis, if at all? 55

56 Throwback/Throwout: Foreign Sales (Cont.) Apply U.S. jurisdictional principles to determine taxability Some states apply U.S. constitutional nexus principles and P.L to foreign countries. Basically, treat the foreign country as if it is one of the states Other states may apply U.S. constitutional nexus principles but not P.L By its terms, P.L applies to interstate and not international commerce. This is favorable for taxpayers in the throwback context; solicitation of sales of TPP alone may be enough to prevent throwback. 56

57 Throwback/Throwout: Foreign Sales (Cont.) Apply the foreign country s jurisdictional principles Requires a taxpayer to understand and apply the country s jurisdictional principles To the extent that these rules are less favorable than an application of U.S. jurisdictional standards, it is questionable as to whether a state can constitutionally apply those rules for throwback purposes. 57

58 Throwback/Throwout: Foreign Sales (Cont.) Treaty protection Suppose that a treaty protects a taxpayer from income taxation in a particular country. Three possibilities: (1) The treaty has no bearing on whether a receipt may be thrown back or thrown out (in other words, apply the principles given in the previous slides). (2) The treaty protection is viewed as depriving the country of jurisdiction to tax. (3) Treaty protection prohibits throwback/throwout. Under the logic of Whirlpool, one might view the foreign country as choosing not to impose an income tax. 58

59 Gary Bingel, EisnerAmper ECONOMIC NEXUS IMPACT ON THROWBACK/THROWOUT

60 Throwback/Throwout: Economic Nexus Provisions How do state doing business rules affect throwback/throwout? Specifically, if a state has an economic nexus statute, to determine throwback/throwout, should a taxpayer apply those economic nexus provisions? Yes otherwise, would violate internal consistency doctrine Example Assume a California taxpayer has more than $500,000 in sales of TPP destined for State X. Further assume that the taxpayer is not protected by P.L in State X. Under these facts, the taxpayer would not have to throw back sales made into State X to California. Chief Counsel Ruling

61 Throwout Rule: Lorillard Licensing Lorillard Licensing Company, LLC, NJ Tax Ct. Dkt No (8/9/13) Held that New Jersey must apply the same nexus standard when applying the throw-out rule as it applies when imposing nexus on foreign companies. Thus, New Jersey must use an economic nexus standard for determining whether the throw-out rule applies to an intangible holding company. Decision essentially negates the application of the throw-out rule for IHC s. 61

62 Gary Bingel, EisnerAmper OTHER PTE APPORTIONMENT ISSUES

63 Other PTE / Apportionment Issues Generally, absent a unitary relationship, a state should not require the flow-through of factors. However, some states do require just this. E.g., NY flows up factors apparently without regard to whether a unitary relationship exists. NY Reg. Sec (a)(5) 63

64 Other PTE Apportionment Issues I. Possible factors to consider include: Is there a unitary relationship? Did the owner elect flow-through treatment for the PTE (as opposed to it being the default)? Limited liability? Is ownership freely transferable? Is ownership greater than 50%? Is the ownership an investment? 64

65 Other PTE Apportionment Issues I. The following states require partnership income to be specifically allocated based on where earned: LA Sec. 47: A(5). MS Reg. Sec. 35.III.8.06 Part II.8. OK Reg. Sec. 710: (15). 65

66 Other PTE Apportionment Issues I. Some states that treat PTE income as apportionable income treat distributive share as a receipt and include as part of receipts factor without flowing up property and payroll factors. Kentucky KY Rev. Policy 41P200 (6/1/83). 66

67 Other PTE Apportionment Issues I. What about business / non-business income determination? Is it made at the owner s level or the PTE level? Most states don t address Illinois determination is made at the partnership level. 86 ILAC (b)(1). Pennsylvania determination is made at the owner s level. PA Sec (c)(2). 67

68 Other PTE Apportionment Issues I. When flowing-through the apportionment factors of the PTE to the owners, should intercompany transactions be eliminated? Transactions between the PTE and the owner? Transactions between commonly owned PTE s? 68

69 Other PTE Apportionment Issues For Illinois purposes, transactions between PTE and its owner are eliminated. IL DOR Ruling IT PLR (5/19/08). California provides for eliminations. CA Reg. Sec (f). Pennsylvania also eliminates intercompany transactions PA Reg. Sec Oregon provides for elimination between a corporate member and LLC s. OR Reg. Sec (9) 69

70 Other PTE Apportionment Issues I.When calculating the apportionment factors of the owner of a PTE, what percentage do you use to determine the owner s share of the PTE s factors? A. Profits %? B. Capital %? i. MA Reg. Sec (12)(f). i. AK Reg. Sec (a) ii. CA Reg. Sec (f)(4) C. What about special allocations? i. MA Reg. Sec (12)(f). 70

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