Current corporate income tax developments.

• Author: Boucher, Karen J.
• Position: Part 2

During 2009, numerous state statutes were added, deleted, or modified; court cases were decided; regulations were proposed, issued, and modified; and bulletins and rulings were issued, released, and withdrawn. Part I of this article, in the March issue, focused on nexus, tax base, allocable/apportionable income, and Sec. 338(h)(10) transactions. This part covers some of the more important developments in apportionment, unitary groups/filing methods, administration, flowthrough entities, and other significant corporate state tax issues.

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Apportionment

A multistate corporation apportions its business income among the states using an apportionment percentage for each state having jurisdiction to tax the corporation. To determine the apportionment percentage, the corporation computes a ratio for each of the factors included in the state's formula. Each ratio is calculated by comparing the corporation's level of a specific activity in the state with the total corporation activity of that type everywhere; the ratios are then summed, weighted (if required), and averaged to determine the corporation's apportionment percentage for the state. The apportionment percentage is then multiplied by total corporation business income.

While apportionment formulas vary, many states use a three-factor formula that includes sales, payroll, and property factors. Because use of a higher-weighted sales factor generally provides tax relief for in-state corporations, most states accord more weight to the sales factor than to the other factors. States may also use changes in the apportionment formula to provide relief or tax benefits to specific industries or to properly reflect the operations of a particular industry. Recent apportionment developments are summarized below.

Arizona

An Arizona court of appeals held that use of costs of performance is the proper sourcing mechanism for sales of mortgage loans and servicing rights and that net gains on such sales must be included in the denominator of the sales factor. (1)

California

SB X3 15, Laws 2009, includes the following apportionment changes starting in 2011: (1) businesses (other than financial and agricultural corporations) will be allowed to elect a single sales factor apportionment formula; (2) market sourcing will be adopted for sales other than sales of tangible personal property; (3) treasury receipts and certain other receipts will be excluded from the sales factor; and (4) the Finnigan approach will be adopted so that sales of tangible personal property to California are included in the numerator of the sales factor if any member of the combined group has nexus in California (with a corresponding effect on the throwback rule). (2)

In a judicial development, a California Court of Appeal held that the buying and selling of futures commodities created sales income under the general Uniform Division of Income for Tax Purposes Act provisions because it was an integral part of the company's business activity; therefore, the income constituted gross receipts for sales factor apportionment purposes. (3) However, the court remanded the case back to the trial court to determine whether the California Franchise Tax Board (FTB) had met its burden of proof regarding whether it was distortive to include the hedging receipts in the sales factor at the gross amount.

Colorado

For years beginning after 2008, HB 1311, Laws 2009, provides that sales made by a mutual fund service corporation providing management, distribution, and administrative services for a regulated investment company (RIC) are included in the numerator of the sales factor to the extent that the shareholders of the RIC are domiciled in Colorado. In light of this law change, the Department of Revenue (DOR) proposed new regulations Sections 39-22-303.7.1 and 7.2 to provide definitions and calculation information about the sourcing of sales of mutual fund service corporations.

Idaho

The State Tax Commission (STC) adopted Rule 550, addressing the sourcing of income from intangible property and implementing the Multistate Tax Commission's (MTC) rule requiring the inclusion of personal services performed by unrelated third parties acting on behalf of the taxpayer in computing income-producing activity and costs of performance for certain sales of other than tangible personal property.

Kansas

Effective July 1, 2009, HB 2270, Laws 2009, relaxes a timing requirement for manufacturers seeking to qualify for the use of a single sales factor apportionment formula by extending the deadline for hiring 100 new employees at their new instate facilities by up to six months upon a showing of good cause and after receiving state certification of substantial compliance. The original 2007 legislation had allowed single sales factor apportionment at certain new in-state manufacturing facilities that hired at least 100 new employees by December 31, 2009.

Maine

For tax years beginning after 2008, the corporate sales apportionment factor must now exclude from both the numerator and the denominator sales of tangible personal property that are delivered to a state where the taxpayer is not taxable. (4)

Michigan

The Michigan Tax Tribunal granted summary judgment in favor of an employment management company, holding that the company's receipts from the sales of employment services must be sourced according to the particular leasing agreement contracts, rather than based on a particular employee's wages, under the former single business tax (SBT). (5)

In another development, the Michigan Court of Appeals held that an in-state limited liability partnership that provided legal services to clients within and outside Michigan was entitled to source its income under the former SBT both inside and outside Michigan, as each 15-minute increment of legal service work provided to its clients constituted a separate unique business activity that must be apportioned to the state in which the activity was performed. (6)

In two separate cases addressing the former SBT, the Michigan Court of Appeals ruled in favor of the state and held that interest income from loans secured by real property located in Michigan and unsecured loans provided to Michigan customers must be sourced to Michigan even though the interest payments were not received in Michigan. (7)

Missouri

The DOR ruled that a national marketer/processor of prepaid debit cards and related services that is subject to the corporate income tax has a choice of apportioning its revenue streams under either the single sales factor or the three-factor apportionment method. (8) The DOR also set forth how the company's sales would be sourced under both methods.

New Mexico

HB 75, Laws 2009, extends the use of the double-weighted sales factor formula for qualified manufacturers from its original expiration date after 2010 to expiration by 2020.

New York

For purposes of the business allocation percentage under Article 9-A, fees for arranging for the provision of a medical service to be rendered by a third-party physician are sourced to New York if the medical service is performed in New York. (9) In addition, monthly fees for website advertising services must be sourced to New York based on the ratio of persons who view the ads in New York to the number of persons ads in New York to the number of persons who view the ads everywhere. If the company does not have any way of knowing where a prospective customer is when he or she views or reads an advertisement on the website, it may use some reasonable method to estimate the ratio, subject to the DOR's approval.

New York City

A8867, Laws 2009, conforms to the state rules for customer-based sourcing for registered broker-dealers and, over a 10-year period, phases in a single sales factor apportionment formula for the general corporation and the unincorporated business taxes. As under state law, a partial single sales factor phase-in also applies under the bank tax for corporations whose income is substantially derived from providing certain services to mutual funds. In addition, the existing law permitting manufacturers to elect a double-weighted sales factor will no longer be available for tax years beginning after 2010.

North Carolina

For tax years beginning after 2009, SB 575, Laws 2009, offers current or expanding capital-intensive companies that meet certain in-state investment and quality jobs criteria the option to use single sales factor apportionment (as opposed to the standard three-factor, double-weighted sales formula).

Oregon

SB 182, Laws 2009, modifies the definition of financial corporation starting with the 2009 tax year and, for the traditional listed financial institutions other than subsidiaries of such institutions, for all open tax years for appeal/audit/adjustment or refund. Financial corporations apply special industry apportionment provisions in determining their income apportionable to Oregon.

Pennsylvania

HB 1531, Laws 2009, increases the weighting of the sales factor to 83% for 2009 (previously 70%); after 2009, the sales factor weighting will be 90%.

South Carolina

The DOR issued guidance regarding statutory provisions enacted in 2006 that began to phase in single sales factor apportionment for certain in-state manufacturers for tax years beginning after 2006. (10)

Tennessee

A Tennessee court of appeals reversed a chancery court decision to hold that the DOR's variance from the greater costs of performance sourcing method to a market-sourcing method in connection with the sale of advertising by a telephone directory publisher was appropriate. (11) Under the standard costs of performance method, a significant amount of the publisher's revenue was received from the sale of advertisements in Tennessee but was not sourced to Tennessee.

Texas

Texas Tax Code Section 171.106(f) provides that if a loan or security is treated as inventory of the seller for federal income tax purposes, the gross proceeds of the sale of...