* Many states have increased the sales factor or are phasing in a single sales factor over a period of years.
* California conformed to certain AJCA tax-shelter reporting requirements for material advisors and listed transactions.
* A number of states passed laws establishing or modifying passthrough entities' duty to withhold on nonresident owners.
This two-part article discusses a myriad of recent state tax activity in the corporate income tax area. Part II addresses developments on apportionment, filing methods/unitary groups, administration and other significant state tax developments.
During 2005, 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cases were decided; regulations were proposed, issued and modified; and bulletins and rulings were issued, released and withdrawn.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 2006 issue, focused on nexus, Internal Revenue Code (IRC) Sec. 338(h)(10) transactions, allocable/apportionable income and tax base. Part II, below, covers some of the more important developments in apportionment, unitary groups/filing methods, administration and other significant corporate state tax issues.
A multistate corporation's business income is apportioned among the states using an apportionment percentage for each state with 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.
Increased Weighting of Sales Factor
For tax years beginning after 2006, corporations will be allowed to annually elect a super-weighted sales factor apportionment formula. If the election is made, the sales factor will be weighted 60% for 2007, 70% for 2008 and 80% after 2008. If a corporation elects the super-weighted sales factor, it must participate in an economic impact analysis tracking the number and value of investments by the electing entities. Further the super-weighted sales factor provisions will not go into effect unless specified targets for investment in the state are met. (58)
HB 191, Laws 2005, phases in a 100% sales factor formula; the sales factor will be weighted 80% for 2006, 90% for 2007 and 100% after 2007.
For tax years beginning after 2005, HB 679, Laws 2005, increased the sales factor to 100% for businesses primarily engaged in manufacturing or merchandising.
Under SB 634, Laws 2005, the weighting of the sales factor is increased from 90% to 92.5% for 2006 and 2007, and to 95% after 2007.
A single sales factor apportionment formula is being phased in over an eight-year period, beginning in 2007. (59) For tax years beginning in 2007, the sales factor will be increased from 75% to 78%. The sales factor will then gradually increase each year until it reaches 100% in tax years beginning after 2013.
* New York
A single sales factor apportionment for corporations taxed under Article 9-A (general business corporations) is being phased in; the sales factor weighting will be 60% for 2006, 80% for 2007 and 100% for tax years beginning after 2007. Banks and other corporations subject to Article 32 generally are not subject to single-factor apportionment except with respect to income from management and administration of investment companies. For this income, single-factor apportionment will be phased in over a three-year period with the following phase-in percentages: 50% sales, 17% payroll and 33% deposits for 2006; 70% sales, 10% payroll and 20% deposits for 2007; and 100% sales for tax years beginning after 2007. (60)
SB 31, Laws 2005, accelerated the 100% sales factor formula to be effective for tax years beginning after June 30, 2005.
For tax years beginning after 2005, HB 78, Laws 2005, allows taxpayers to make a five-year irrevocable election to apportion business income using a double-weighted sales factor.
Other Apportionment Developments
The Tax Appeals Board ruled that only the net gain on the sale of mortgages should be included in the sales factor and that the mortgage company's sale of the mortgages was not a separate income-producing activity, thus requiring inclusion in the numerator of the sales factor for net gains realized on mortgages backed by Arizona properties and any sales originating from sales activities in Arizona. (61)
The Franchise Tax Board (FTB) provided guidance on what constitutes a "personal service" for purposes of attributing gross receipts to the California sales factor using the "time spread" method, under which the time each employee spends in each state constitutes a separate income-producing activity. (62)
Two decisions during 2005 addressed whether certain treasury functions should be reported at gross or net proceeds for sales factor apportionment purposes. In an unpublished decision, (63) a California Court of Appeal affirmed that a retail store's returns of principal from debt instruments held to maturity are not "sales" within the meaning of the state's Uniform Division of Income for Tax Purposes Act apportionment provisions and, accordingly, are not includible in the sales factor as gross receipts. In a different case, the California Court of Appeal held that receipts from Microsoft's sale of short-term marketable securities must be excluded from the apportionment formula sales factor. (64)
The Department of Revenue (DOR) ruled that the Indiana-source sales of a business that provides financial market data collected in California to customers nationwide via cable boxes and similar means are determined by the subscription fee income received from Indiana customers, because the fee is the income-producing activity that occurs when data is received in Indiana. (65)
In a case involving dock sales, the Indiana Tax Court ruled that sales of beer to Indiana customers were not sourced to the state for adjusted gross income tax purposes because delivery took place outside the state with third-party common carriers acting as agents for the customers in retrieving the beer from the seller's out-of-state breweries and bringing it into Indiana. (66)
The Supreme Judicial Court both vacated in part and sustained in part the appellate court's apportionment factor inclusion and sourcing ruling involving the owner of the Boston Bruins hockey team. (67) The court sustained that gate receipts and local broadcast licensing revenues of "away games" were fully sourced to Massachusetts--the gate receipts under income-producing activity/cost or performance analysis, and the broadcast licensing revenues based on "actual use" or where the...