Current corporate income tax developments.

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

EXECUTIVE SUMMARY

* California legislation imposes new tax shelter registration and listing requirements and substantial penalties for noncompliance.

* Texas law limits refund claims for 2004-2005 to $250,000; the legislature must specifically appropriate the funds for any higher refund claims.

* Several states have enacted legislation requiring flowthrough entities to withhold on distributions to nonresident owners.

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This two-part article discusses the most significant recent state tax developments in the corporate income tax area. Part II describes some of the more important developments in apportionment formulas, filing methods/unitary groups, administration, tax increases and other significant miscellaneous issues.

During 2003, 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cases were decided; regulations were proposed, issued and modified; and bulletins and rulings were issued, released and withdrawn.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 1 of this article, in the March 2004 issue, focused on nexus, tax base, business/nonbusiness income and trademark/tradename issues. Part II, below, covers some of the more important developments in apportionment formulas, unitary groups/filing methods, administration and other significant corporate state tax issues.

Apportionment

A multistate corporation's business income is apportioned among the states using an apportionment percentage for each state having jurisdiction to tax the corporation. To determine the apportionment percentage, a ratio is established 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 to 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. Changes in the apportionment formula may also be used 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.

* Alabama

An administrative law judge (ALJ) sustained (54) a Department of Revenue (DOR) audit position that, while a miles-traveled ratio may not exactly reflect the time leased railcars were physically present or used in the state, it provided a more reasonable approximation for the lessor's sales factor than customers' billing addresses.

* California

The Franchise Tax Board (FTB) ruled (55) that dividends received are not included in the sales factor, even though they may be business income, unless the recipient participates in the dividend payer's management or operations.

Microsoft's gross proceeds from a sale of marketable securities should be included in the sales factor of the apportionment formula. (56) The court found it irrelevant whether such instruments were sold before, or at, maturity; and that the FTB did not present any significant evidence of distortion.

The State Board of Equalization (SBE) held (57) that Polaroid's patent infringement award had to be included in its sales factor, because the receipts were analogous to unrealized profits from lost sales of cameras and film. The SBE also held that only the net income from short-term financial instruments should be included in the sales factor, because the activity was unrelated to the main line of business and gross proceeds would distort the sales factor's purpose.

In a Superior Court case, (58) including gross proceeds from short-term investments held to maturity in the sales factor did not comport with a practical view of legislative intent. According to the court, the return of the taxpayer's capital from such transaction would not reflect the market for goods/services captured by the sales factor.

In another case, (59) the "gross" method of reporting sales-factor receipts from treasury department functions was denied; when compared to the company's $26.7 billion of product sales, inclusion of $36.5 billion sourced to its New Jersey treasury department function would grossly distort the sales-factor denominator.

* Delaware

The State Supreme Court held (60) that gain on the sale of real estate located in the state is fully allocable to Delaware, even though, after apportionment by other states, 187% of the gain was subject to tax. The court ruled that the statute was clear; any taxation disparity is diminished, because the state does not tax out-of-state real property sales.

* Florida

A Circuit Court granted (61) the DOR summary judgment, ruling that a Florida financial organization's interest and dividend proceeds generated from securities managed by an investment committee in Alabama are included in the Florida sales-factor numerator, because the underlying assets could not be severed from the financial organization.

* Illinois

A member of an Illinois combined report cannot claim affiliate nexus to prevent throwback of its separate-company sales; the Appellate Court ruled (62) that the word "person," in the Illinois throwback provisions, refers only to an individual unitary member.

* Indiana

The DOR ruled (63) that proceeds from insurance information, managed and assembled outside the state, are Indiana sales when the information is provided to in-state customers.

* Massachusetts

Under cost-of-performance sourcing rules, 100% of the Boston Professional Hockey Association's revenues from licensing broadcasting rights and trademarks and its pro-rata sales of its unitary limited partnership interest, were includible in its Massachusetts sales-factor numerator. (64)

* Minnesota

The state Supreme Court affirmed (65) that the "consumer" of management services provided to a mutual fund is the mutual fund, not its ultimate investors. Thus, fees for such services are properly attributed to the state in which the mutual fund is located (Minnesota).

* New Mexico

The DOR (66) ruled that a special allocation/apportionment agreement between the DOR and the Atchison, Topeka and Santa Fe (AT&SF) railway could not be applied once AT&SF ceased to exist after a merger with Burlington Northern. Despite the companies' plan of merger, specifying that the survivor would succeed to "all rights, privileges, powers and franchises" of AT&SF, the allocation/apportionment agreement was "personal," not a right that could be sold or assigned.

* Ohio

HB 95, Laws 2003, adopted the Uniform Division of Income for Tax Purposes Act (UDITPA) definition of business income, essentially eliminated Ohio's prior allocation provisions and sourced sales of services based on greater cost of performance. HB 127, Laws 2003, amended the new sales sourcing rules to provide that sales of services are sourced based on where the benefit is received; the physical location where the purchaser ultimately uses or receives the benefit of the original purchase is paramount in determining the benefit.

The Board of Tax Appeals held (67) that ORIX Credit is a finance company and, thus, all of its gross rents and net business property gain/loss should be considered apportionable interest income for Ohio franchise tax purposes.

* Oregon

Under HB 3183, Laws 2003, the current 80% sales factor of the apportionment formula will increase to 90% for tax years beginning after June 30, 2006, and to 100% for tax years beginning after June 30, 2008. Cars leased for nonemployee sales consultants as part of Mary Kay Cosmetics' Career Car Program were properly...