Current corporate income tax developments.

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

EXECUTIVE SUMMARY

* A number of states passed laws or issued regulations that modified their apportionment formulas or specified that certain items were to be included or excluded in apportionment factors. Colorado switched from a multi-factor to a single-factor apportionment formula.

* Unitary group/filing issues were addressed in state court decisions, legislation, regulations, and rulings. Massachusetts passed legislation requiring unitary combined reporting for tax years after 2008.

* Massachusetts passed legislation that provides for a phased-in reduction in its corporate tax rate to 8% and in its financial institutions tax rate to 9% for 2012. Similarly, Kansas passed legislation that reduces its former 7.35% corporate income tax rate to 7% for tax years beginning after 2010.

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During 2008, 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were decided; regulations were proposed, issued, and modified; and bulletins and rulings were issued, released, and withdrawn.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 2009 issue, focused on nexus, allocable/apportionable income, and tax base. Part II, below, covers some of the more important developments in 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.

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.

Gross Versus Net Proceeds

California

The California Office of Administrative Law issued final approval of amended Regulation [section] 25137(c)(1)(D) to exclude certain receipts of a corporation's treasury function from the sales factor of the corporate income tax apportionment formula. For tax years beginning after 2006, the amended regulation excludes interest and dividends from intangible assets held, as well as gross receipts and overall net gains from the maturity, redemption, sale, exchange, or other disposition of such intangible assets.

In the first "gross versus net" sales factor apportionment administrative decision since the Microsoft (1) and General Motors Corp. (2) California Supreme Court cases, the California State Board of Equalization (SBE) ruled in favor of the taxpayer, finding that the California Franchise Tax Board (FTB) did not show that (1) including the gross receipts generated from the redemption of its marketable securities in the receipts factor was distortive and (2) including only the net receipts generated from the redemption of those marketable securities was reasonable. (3)

Kansas

For tax years beginning after 2007, S Sub HB 2434, Laws 2008, provides that in the case of sales of business assets, other than sales of tangible personal property sold in the ordinary course of the taxpayer's trade or business, only the net gain from such sales shall be included in the sales factor.

Kentucky

For tax years beginning after 2007, HB 258, Laws 2008, provides that the sales factor includes the net gain from treasury function transactions involving liquid assets.

Ohio

The Ohio Supreme Court held that for the years at issue, taxpayers must use net proceeds on principal trades, rather than gross proceeds, in determining apportionment for the dealers in intangibles tax. (4)

Other Apportionment Developments

California

The SBE held that the FTB's special trucking industry "interstate ratio" apportionment formula applied to all members of a taxpayer's combined reporting group, rather than just the specific "trucking company" entities within the group. (5) The taxpayer unsuccessfully argued that the state's general apportionment rules should apply to the "non-trucking company" members of the group.

Colorado

For tax years beginning after 2008, HB 1380, Laws 2008: (1) replaces the two- and three-factor apportionment options with a single sales factor formula that includes a throwback rule for sales and leases of tangible personal property and certain patents and copyright royalties; and (2) sources mutual fund services based on the domicile of the shareholders.

Delaware

The U.S. Supreme Court has denied review of a Delaware Supreme Court's ruling affirming Delaware's imposition of a bank franchise tax on 100% of a Delaware-chartered federal bank's income even though most of its employees (including senior management) worked in New York. (6)

In another development, for tax years beginning after 2008, SB 213, Laws 2008, permits asset management corporations to apportion their income based on a single ratio of Delaware-sourced gross receipts from asset management services to total gross receipts from asset management services based on the domicile of the consumer. Subsidiaries of certain banking organizations and trusts are prohibited from sourcing their income under this method.

Illinois

SB 783, Laws 2008, repeals the proportional benefits test and instead sources income from the sales of services to the place where the services are received. This legislation also adds a completely new code of provisions to the sales factor section for taxpayers that provide telecommunication services; requires that receipts from certain intangible property items are sourced to Illinois if a greater proportion of the income-producing activity of the taxpayer is performed in Illinois than in any other state, based on performance costs; provides that a dealer in intangible property sources receipts from intangible property (e.g., interest and net gains) to the customer's residence or commercial domicile, if the taxpayer has actual knowledge of those matters (otherwise, the sourcing of these receipts is to the customer's billing address); and revises some of the PA 95-0233 changes in the way that the apportionment fraction is computed for financial organizations beginning in 2008.

Maine

Maine Revenue Services adopted amended rules 18-125 ME Code R. 810 and 801 to reflect the law (Ch. 240 (LD 499), Laws 2007), which for tax years beginning after 2006 applies single sales factor apportionment and market sourcing for sales of other than tangible personal property to calculate the corporate income tax.

Massachusetts

The Department of Revenue (DOR) amended regulation 830 MA Code Regs. 63.38.7, which deals with apportionment for mutual fund services, to address the question of how a corporation computes the apportionment percentage for its non-income measure when the corporation has non-mutual fund income and derives a loss from either or both of its mutual fund and non-mutual fund businesses.

In another development, the Massachusetts Appellate Tax Board held that a travel company that created and marketed vacation travel packages to primarily foreign destinations must source all of its receipts to Massachusetts for sales factor purposes under an "operational approach" for examining the income-producing activity. (7)

Michigan

HB 5151, Laws 2008, which is effective retroactively to tax years beginning after October 31, 2005, provides that receipts derived by a mortgage company (that does not meet the definition of a financial organization) from the origination or sale of a loan secured by residential real property are apportioned in the same manner as for financial organizations.

New Jersey

Denying the taxpayers' motions for summary judgment, the New Jersey Tax Court held that while the state's throw-out rule may operate...