Current corporate income tax developments.

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

During 2010, 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were decided; regulations were proposed, issued, and modified; and bulletins and rulings were issued, released, and withdrawn.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 updates regarding nexus, tax base, allocable/apportionable income, and Sec. 338(h) (10) transactions. Part II, below, covers some of the more important developments in the areas of apportionment, unitary groups/filing methods, administration, flowthrough entities, and other significant corporate state tax issues.

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 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.

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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. Some of the more significant recent apportionment developments are summarized below.

Arizona

The Arizona Department of Revenue (DOR) explained that because the conditional requirements included in HB 2139, Laws 2005, were met, for tax years beginning from and after December 31, 2008, multistate corporate taxpayers (except those engaged in air commerce) must select the use of either the standard sales factor formula (property factor plus payroll factor plus two times the sales factor with a denominator of four) or the enhanced sales factor formula (property factor plus payroll factor plus eight times the sales factor with a denominator of ten). (1) In exchange for electing to use the enhanced sales factor formula, taxpayers agree to disclose their names to Arizona's Joint Legislative Budget Committee and to participate in an economic impact study.

In another development, the DOR explained that because an Arizona affiliated group is considered to be a single taxpayer for purposes of apportionment, all the sales that flow through from a partnership to the corporate partners' sales factor are intercompany sales that must be eliminated unless these intercompany sales are inconsequential. (2)

California

As amended, California's cost of performance regulation includes consideration of transactions and activities performed on behalf of a taxpayer by an agent or independent contractor in determining the state to which receipts from sales, other than sales of tangible personal property, should be assigned. (3) The amended regulation applies retroactively to tax years beginning after 2007.

In addition, the Franchise Tax Board (FTB) voted to move forward with the formal regulatory process to adopt the draft market-based sales factor regulation that for tax years beginning after 2010 will (if it is formally adopted) affect taxpayers that generate revenue from services or intangibles (including royalties) and that are (1) currently filing in California and plan to elect into the single sales factor method of apportionment, thus requiring market-based sourcing for apportionment, or (2) not currently filing in California and will thus be required to determine, by application of market-based sourcing, whether they are doing business in the state under the economic nexus rules.

In a legislative development, SB 858, Laws 2010, modifies the sales factor provisions that apply to tax years beginning after 2010, for assigning sales other than sales of tangible personal property by reinstating the costs of performance (rather than market) sourcing rules for taxpayers that do not elect to use a single sales factor apportionment formula and requiring market sourcing for taxpayers making the election.

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On the judicial front, on remand from the California Court of Appeal's 2009 ruling, a California superior court concluded that (1) General Mills's futures trading activity was qualitatively different from its primary business, (2) there was quantitative distortion under various tests drawn from case law, and (3) the FTB's proposed alternative apportionment formula (to include only net income from commodity futures contracts) was reasonable. (4)

In addition, pending litigation in the San Francisco Superior Court under the lead case of Gillette Co. addresses a taxpayer's ability to elect and apportion its income under the Multistate Tax Compact provisions (evenly weighted three factor) instead of California's four-factor formula that double-weights the sales factor. (5)

Colorado

The Colorado DOR amended various industry apportionment rules to implement single sales factor apportionment that was effective for tax years beginning after 2008 and to make various other changes. (6) The DOR also adopted new CO Code Regs. Sections 39-22-303.7.1 and 7.2 to implement 2008 legislation that sources sales made by a mutual fund service corporation providing management, distribution, and administrative services for a regulated investment company (RIC) to the domicile of the RIC's shareholders for tax years beginning after 2008.

Idaho

The Idaho State Tax Commission (STC) amended Rule 450 (7) to provide that when determining an entity's apportionment factors, intercompany transactions should be eliminated only "to the extent necessary" to properly compute the numerators and the denominators of the apportionment factors of a combined group. The STC also amended Rule 570 (8) to provide that commissions and fees related to the sale of another taxpayer's real property are sourced to the state where the property related to the commission and fees is located.

Indiana

The Indiana DOR explained to a media corporation that it failed to show why the DOR's equitable discretionary use of an audience factor method of apportionment did not fairly reflect its corporate income from Indiana sources. (9) The corporation had failed to give the auditor a 50-state apportionment schedule "necessary to determine the nature and types of revenue earned"; thus, the auditor used a Nielsen's audience factor ratio to apply income attributable to Indiana. The company was also required to include in its consolidated return two subsidiary cable networks that did not have physical presence in Indiana because their income was found to be tied to service subscriptions from Indiana residents.

Maine

LD 1671, Laws 2010, adopted the Finnigan (10) approach for corporate income tax purposes. Under this approach, when calculating the numerator of the sales factor, Maine sales include sales of the taxpayer and of any member of its affiliated unitary group; for purposes of the sales factor throwout rule, the sales factor excludes from both the numerator and the denominator sales of tangible personal property delivered or shipped to a purchaser within a state in which neither the taxpayer nor any member of its affiliated unitary group is subject to tax.

Maine Revenue Services (MRS) proposed amendments to Rule 801 (apportionment of income) to expand the discussion of water's-edge reporting, reflect recent legislative changes (including adoption of the Finnigan rule, the repeal of the throwback rule, and the adoption of the throwout rule), and provide new definitions of "taxpayer" and "unitary business."

MRS also amended Rule 810 (unitary income and combined returns) to provide guidance on water's-edge filing, to reflect recent legislative changes (including the Finnigan rule), and to clarify that members of a unitary group filing a combined return are jointly and severally liable for the tax.

Michigan

In a case involving the former single business tax (SBT), the Michigan Court of Appeals affirmed that because a taxpayer was in the business of remanufacturing buses and not merely the sale of bus parts, revenue from the sales at issue was from "other than tangible personal property" and thus was sourced based on where the services were performed (i.e., Michigan). (11)

In another decision involving the former SBT, the Michigan Tax Tribunal held that a hotel management company that performs services for hotels within and outside Michigan must source its income earned from in-state hotels to Michigan because the greater of the cost of performance to operate each hotel in Michigan occurred in Michigan. (12)

New Jersey

The New Jersey Superior Court, Appellate Division, affirmed that while the sales factor throwout rule may operate unconstitutionally in some applications, the rule was facially constitutional.(13) The New Jersey Supreme Court has granted review of this decision.

New York

The Department of Taxation and Finance issued proposed amendments to update the administrative procedures for requests for discretionary adjustments to the method of allocation for state business corporation and bank franchise tax purposes to, among other changes, provide that the taxpayer's request be made separate and apart from the filing of the return and to eliminate the requirement that taxpayers must in every instance submit the computation of tax under the proposed method. (1)

In a decision regarding rights to broadcast particular programs, an administrative law judge (ALJ) ruled that...