The Dbriefs Multistate Tax Series Presents
State Income Tax Apportionment: Time to Look Beyond the General Ledger Norm Lobins, Deloitte Tax LLP Tom Cornett, Deloitte Tax LLP
December 3, 2013
Overview
Agenda Background and Relevant Cases Current Application and Observations Multistate Tax Compact – Current Developments Recent Developments in Cost of Performance and Market Sourcing Questions and Answers
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Poll question #1 Regarding apportionment, our company finds most challenging: • • • • • •
The property factor The payroll factor The receipts factor All the factors are difficult None of the factors are difficult Do not know / Not applicable
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Background and relevant cases
Background Inconsistencies between financial statements and apportionment formulas • Property • Payroll (more appropriately compensation) • Sales (more appropriately receipts) Accordingly, further analysis may be required
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Background Assets on balance sheet (or rents in rent expense) but NOT in apportionment formula • • • • •
Outer jurisdictional property (e.g., satellites) Construction in progress In-transit inventory Retired property Intangible property – Notwithstanding it may be income producing property – Exception for certain financial businesses
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Background Assets NOT on balance sheet (or rents not in rent expense) but included in apportionment formula • Government provided property • “Free” use property • Warehousing Fees
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Background Wages in payroll tax returns but NOT in apportionment formula
• Officers‟ compensation • Leased employees • Common paymaster arrangement
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Background Wages NOT in payroll tax returns but included in apportionment formula • Common paymaster arrangement • Contractors • Leased employees
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Relevant cases Sales versus service and mixed transactions • Does nomenclature control? Do separately stated items control? • Midwest Bus Corporation v. Michigan Department of Treasury, No. 288686 (Mich. Ct. App. March 16, 2010) – Court reviewed contract for bus repair services. Held that the predominant purpose of the bus owner was to engage the taxpayer to provide a “remanufacturing” or “rehabilitation” service – Transfer of TPP was incidental to providing this service despite fact that volume and value of TPP provided significantly exceeded value of service provided • Michigan Production Machining, Inc. v. Michigan Dept. of Treasury, No. 312224 (Mich. Ct. App. Nov. 12, 2013) – Court held that taxpayer engaged in the sale of tangible auto parts, even when its customers had arranged for the purchase of the required raw materials – Taxpayer‟s possession of raw materials was significant 6 Copyright © 2013 Deloitte Development LLC. All rights reserved.
Relevant cases “Ship to” address not used for sales of tangible personal property • Pre-labeled for further distribution • Further transportation by customer – McDonnell Douglas v. Franchise Tax Board 26 Cal. App. 4th 1789 (1994) – Appeal of Mazda Motors, Inc., 94-SBE-009 (November 29, 1994) • Customer pick up (“dock sales”) • Michigan MBT provision – “Property stored in transit for fewer than 60 days prior to receipt by the purchaser or the purchaser's designee, or in the case of a dock sale not picked up before 60 days, is not deemed to have come to rest at this ultimate destination” 8
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Relevant cases “Ship to” address of ultimate purchaser • Drop shipments • Uniloy Milacron USA Inc. v. Michigan Department of Treasury, No. 300749 (Mich. Ct. App. January 26, 2012) – Intermediate purchaser never took possession of sold property – Court held that drop shipment sales were sourced based on location to which the product was ultimately shipped, not based on the location of intermediate purchaser
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Poll question #2 The method that best describes our company‟s process for developing apportionment data is the following: • Straight from the general ledger or ERP system • Straight from a financial consolidating package (e.g., Hyperion) • From one of the above into spreadsheets for further analysis • Custom tax reports from an ERP system • It has been programed into the tax reporting package • Not applicable
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Current application and observations
Current application and observations Contemporary business practices • Logistic practices – Customer directed delivery
• Increase in service revenues – Post-sale services – Insurance – Other
• Mobile workforce
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Multistate Tax Compact – current developments
Multistate Tax Compact Election • Many full-member states of the Multistate Tax Compact have
modified the apportionment rules in UDITPA or have rules that override the rules of UDITPA • Key provisions of UDITPA that potentially differ from state apportionment rules include: - Equally-weighted, three-factor apportionment formula - Cost-of-performance for sales of non-TPP - Broad definition of “sales” • Original vs. amended return • Potential penalties
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Multistate Tax Compact Election - Michigan IBM v. Michigan Dept. of Treasury, No. 306618 (Mich. Ct. App. Nov. 20, 2012)
Michigan Court of Appeals held for the Michigan Department of Treasury, and determined that MTC election was not available. • The MBT Act and the Compact were in “irreconcilable conflict” and could not be harmonized. • Later enacted MBT Act “repealed by implication” the Compact • Michigan Supreme Court has agreed to review the Court of Appeal‟s decision in IBM. Decision expected in mid 2014.
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Multistate Tax Compact Election - Michigan Anheuser-Busch, Inc. v. Michigan Dept. of Treasury, Case No. 11-85MT (Order and Opinion, Mich. Ct. of Claims June 6, 2013).
Michigan Court of Claims decision reached a different outcome regarding availability of MTC election for MBT purposes. • Court of Claims agreed with IBM decision, holding that the MBT and the apportionment election provisions of the Compact could not be harmonized. However, contrary to IBM, the Court of Claims held that the enactment of the MBT cannot impair the MTC election provision • MTC is a compact that is binding on its members and cannot be repealed by a conflicting statute. The MTC language demonstrates intent to limit the legislatures„ power under the MTC • The Court stated that the plain language of MTC Article X limits a state‟s ability to withdraw from the MTC to “enacting a statute repealing the same” 12
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Multistate Tax Compact Election - California Gillette Company, et al., v. California Franchise Tax Board, 209 Cal. App. 4th 938 (Oct. 2, 2012) • California Court of Appeal upheld taxpayers‟ right to elect to allocate and apportion income to California using the MTC • The Court refuted, as a violation of federal compact law, the Contract Clause of the U.S. Constitution and the reenactment clause of the CA constitution, the attempt by California to enact statutory constraints on the terms of the MTC • California Supreme Court has granted the FTB‟s petition for review • SB 1015 was enacted on June 27, 2012 in anticipation of the Gillette outcome • FTB guidance 13
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Multistate Tax Compact Election – other states • District of Columbia - Repealed Articles III and IV of the MTC related to apportionment and
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the three-factor Compact election for tax years beginning after December 31, 2012 Minnesota - Repealed remaining element of the MTC contained in MN law (effective 8/1/13) and MN no longer is a full member of the MTC Oregon - Pending case in Oregon Tax Court (Regular Division). - Protective claims may be made, but action on them will be deferred - Effective October 7, 2013, repealed Articles III and IV of the MTC related to apportionment and the three-factor Compact election Texas - Comptroller and ALJ have rejected the use of the MTC‟s 3-factor formula (other cases pending) Utah - Effective 4/1/13, Utah repealed the MTC election provisions Copyright © 2013 Deloitte Development LLC. All rights reserved.
Poll question #3 Has your company filed an original or amended return seeking to make the MTC election? • • • •
Yes, but only for Michigan Business Tax purposes Yes, but only for California franchise tax purposes Yes, for both MBT and California franchise tax purposes Yes, for MBT, California franchise tax and for purposes of at least one other MTC member state • No, our company has not filed a return seeking to make the MTC election in any state • Do not know / Not applicable
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Recent developments in cost of performance and market sourcing
Recent developments in cost of performance and market sourcing Effective market sourcing from perceived cost of performance guidance • Mississippi – Equifax, Inc. v. Department of Revenue, Mississippi Supreme Court, No. 2010-CT-01857-SCT, June 20, 2013 – The department required use of an alternative apportionment method – Taxpayer asserted that such required use amounted to a new rule unduly promulgated in violation of the Mississippi Administrative Procedures Act – The Supreme Court rejected the taxpayer‟s claim 15
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Recent developments in cost of performance and market sourcing Effective market sourcing from perceived cost of performance guidance • Indiana – Letter of Findings No. 02-20130238, Indiana Department of Revenue, September 25, 2013 – Indiana held that the taxpayer did not earn revenue from conducting out-of-state financial research – The taxpayer earned revenue because it conducted financial research and then sold the results of that research to Indiana customers.
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Recent developments in cost of performance and market sourcing California market sourcing For tax years 2011 and 2012, taxpayers that chose not to make a single sales factor election generally continued to use the “costs of performance” rules for assigning sales of other than TPP. For taxable years beginning on or after January 1, 2011 for which a single sales factor election was made and for taxable years beginning on or after January 1, 2013 when mandatory single sales factor apportionment applies: – Receipts from “sales from services” are attributable to California “to the extent the purchaser of the service received the benefit of the service” in California. – Receipts from “sales from intangible property” are attributable to California “to the extent the property is used” in California. 17
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Recent developments in cost of performance and market sourcing California market sourcing Regulation § 25136-2, sourcing for services and intangibles: – Separate rules are provided for determining whether the customer “received the benefit of the service” in California depending on whether the customer is: (1) an individual, or (2) a corporation or other business entity. – Separate rules are provided for determining the place of use for sales of intangible property where (1) there is a “complete transfer of all property rights,” and (2) the “sale” is the licensing, leasing, rental, or other use of the property.
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Recent developments in cost of performance and market sourcing Michigan market sourcing • For both MBT and CIT purposes, services are sourced to Michigan “if recipient of the services receives all of the benefit of the services in this state” • Revenue Administrative Bulletin 2010-5 (“Where Benefit of Service is Received”) provides useful examples, notably – – Services that are directly associated with client‟s own customers – Services that are indirectly associated with client‟s own customers – Services upon mobile TPP brought into state temporarily for purposes of services provided – Consulting services provided to multistate client
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Recent developments in cost of performance and market sourcing Pennsylvania market sourcing • On July 9, 2013, in conjunction with the 2013-2014 Budget process, Pennsylvania Governor Tom Corbett signed House Bill 465 into law • For tax years beginning after on or after January 1, 2014, the receipt from the sale of a service will be sourced to Pennsylvania for apportionment purposes if the service is delivered to a location in the State, or based on the relative value of the services delivered to Pennsylvania
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Recent developments in cost of performance and market sourcing Massachusetts market sourcing • Technical Information Release 13-15, Massachusetts Department of Revenue, October 18, 2013 • Recent legislation provides that sales, other than sales of tangible personal property, are in the state if the corporation‟s market for the sale is in the state • Under law, in effect for taxable years beginning before January 1, 2014, such sales are sourced to Massachusetts if the income-producing activity is performed in Massachusetts. 21
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Recent developments in cost of performance and market sourcing New Jersey proposed market sourcing regulation N.J.A.C. Sec. 18:7-8.10A • Published on April 15, 2013 with standard 60-day comment period • To be effective for privilege periods beginning on of after January 1, 2014 • Statute still requires sourcing based on where the services are “performed” • Regulation sourcing is based on attributable to the state‟s marketplace 22
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Poll question #4 How significant is the effect on your company of states shifting to market sourcing for receipts from sales of services and intangibles? • • • • • •
Significant increase in overall state tax liability Slight increase in overall state tax liability No change in overall state tax liability Slight decrease in overall state tax liability Significant decrease in overall state tax liability Do not know / Not applicable
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Questions and Answers
Join us January 7 at 2 PM ET as our Multistate Tax series presents:
State Income Tax Withholding for Partnerships: Why Is It So Hard?
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Contact info Norm Lobins +1.973.602.5373
[email protected]
Tom Cornett +1.313.396.5808
[email protected]
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