Factually speaking: an overview of the sales factor.

• Author: Liss, Jonathan A.
• Position: State's corporate taxes

Tax executives of multistate corporations are no doubt aware that many state income tax controversies relate to formulary apportionment. Often, the central issue in these disputes is the computation of the sales, or gross receipts, factor. This article addresses several common issues that arise in determining what should be included in the sales factor.

Background: Evolution of the Sales Factor

Prior to the introduction of the three-factor apportionment formula, a taxpayer's income was apportioned by means of a single property factor. In 1957, in order to attain uniformity in state taxation methods, the National Conference of Commissioners on Uniform State Laws formulated the Uniform Division of Income for Tax Purposes Act (UDITPA). Since that time, 43 of the 46 states that impose corporation income taxes have adopted the entire model act or have adopted a similar version of UDITPA.

UDITPA [section] 9 provides for the apportionment of business income by the use of a three-factor formula consisting of property, payroll, and sales. The computation of the sales factor is addressed in sections 15 through 17 of the Act. Under UDITPA, the following "sales" are attributed to a state's sales factor numerator: (1) sales of tangible personal property and (2) all other sales.

In 1966, the Multistate Tax Compact was formed by the National Association of Attorneys General and the National Legislative Council to further the goal of uniformity. The Compact created the Multistate Tax Commission (MTC), an organization with authority to promulgate regulations and conduct multistate audits. States adopting the Compact may elect to use the allocation and apportionment provisions of UDITPA. Most of the Compact's members have adopted UDITPA as their governing apportionment law. Currently, 20 states have adopted the Compact and another 15 states are associate members of the MTC.

Throwback Sales

Section 16(b) of UDITPA sets forth the following "throwback rule":

Sales of tangible personal property are made within

this state if ... the property is shipped from an

office, store, warehouse, factory, or other place of

storage in this state and (1) the purchaser is the

United States government or (2) the taxpayer is

not taxable in the state of the purchaser....

The intent of this rule is to provide a solution to the "nowhere income" problem -- to deal with sales of tangible personal property that would otherwise "escape" inclusion in the sales factor numerator. Section 3 of UDITPA provides two tests for determining whether a taxpayer is "taxable in another state":

* A taxpayer is taxable in another state if it is subject in that state to a net income tax, a franchise tax measured by net income, a franchise tax for the privilege of doing business, or a corporate stock tax.

* A taxpayer is taxable in another state if the state has jurisdiction to subject the taxpayer to a net income tax regardless of whether the state does so in fact.

In the event neither test is met, sales of tangible personal property to purchasers in the other state must be included in (or "thrown back" to) the taxing state's sales factor numerator. These are commonly referred to as "throwback sales."

This article discusses the following issues relating to throwback sales: (1) Massachusetts's "home office" rule; (2) Michigan's jurisdictional test for single business tax purposes; (3) differing throwback rules for the taxable capital and earned surplus components of Texas franchise tax; and (4) application of throwback to combined returns.

Massachusetts law contains an unusual throwback rule which focuses on the "home offices" of sales personnel:

Sales of tangible personal property are in this commonwealth

if ... the corporation is not taxable in

the state of the purchaser and the property was

not sold by an agent or agencies chiefly situated

at, connected with or sent out from premises for

the transaction of business owned or rented by the

corporation outside this commonwealth. (Ch. 63,

Sec. 38(f), G.L.

Therefore, in order to avoid the Massachusetts throwback rule, products must be sold by a sales representative who is associated with a taxpayer's business location (i.e., sales office) outside Massachusetts. The Massachusetts Appellate Tax Board dealt with this issue in A.W. Chesterton Co. u. Commissioner of Revenue (Apr. 18, 1991). A.W. Chesterton, a Massachusetts corporation headquartered in the commonwealth, had no sales offices outside Massachusetts. Chesterton's sales personnel transacted business from their own home offices or hotel facilities paid for by the Company. In addition, there was no evidence to show that Chesterton was taxable in any other state. The Board held that the home offices and hotel facilities were not premises for the transaction of business owned or rented by the corporation outside this commonwealth." Accordingly, Chesterton's sales of tangible personal property were attributed to Massachusetts for sales factor apportionment purposes. The Chesterton case points out the importance of maintaining proper documentation with respect to throwback issues.

With respect to the Michigan Single Business Tax (SBT), several cases have addressed the jurisdictional test to be employed in determining whether Michigan sales should be "thrown back" from destination states. First, the Michigan Court of Appeals in Guardian Industries...