single-sales apportionment: crafting a comprehensive multi...
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Single-Sales Apportionment: Crafting a Comprehensive Multi-State Strategy
Meeting Tax Planning Demands Amid a Dramatic Shift in Apportionment Formulaspresents
Today's panel features:Jon Zefi, Principal, Eisner, New York
Jeffrey Glickman, Partner, State and Local Tax Group, Alston & Bird, AtlantaMitchell Newmark, Of Counsel, Morrison & Foerster, New York
Jon Sedon, Manager, State and Local Tax Group, KPMG, Washington, D.C.Adam Weinreb, Director, Washington National Tax Services Knowledge Management Group, PricewaterhouseCoopers, New York
Wednesday, October 28, 2009
The conference begins at:1 pm Eastern12 pm Central
11 am Mountain10 am Pacific
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A Live 110-Minute Teleconference/Webinar with Interactive Q&A
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Single Sales Apportionment: Crafting a Comprehensive
Multi-State Strategy Webinar
Oct. 28, 2009
Adam Weinreb, PricewaterhouseCoopers Mitchell Newmark, Morrison & [email protected] [email protected]
Jon Sedon, KPMG Jeff Glickman, Alston & [email protected] [email protected]
Jon Zefi, [email protected]
2
Today’s Program
• Legislative Update, slides 4 through 14 (Adam Weinreb)
• Apportionment: Case Law Trends And Developments, slides 15 through 20 (Mitchell Newmark)
• Concurrent Material Issues, slides 21 through 29 (Jon Sedon)
• Resulting Planning Issues, Part I, slides 30 through 44 (Jeff Glickman)
• Resulting Planning Issues, Part II, slides 45 through 58 (Jon Zefi)
3
Legislative Update
4
NOTICE• This document is provided by PricewaterhouseCoopers LLP for general guidance only,
and does not constitute the provision of legal advice, accounting services, investment advice, written tax advice under Circular 230, or professional advice of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult with a professional adviser who has been provided with all pertinent facts relevant to your particular situation. The information is provided “as is” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties, or performance, merchantability, and fitness for a particular purpose.
5
Increased Sales Factor Weighting
• States, in an effort to attract or retain businesses, increase the weight of the sales factor or eliminate the property and payroll factors in favor of a single sales factor
6
Apportionment Formulas* - 1998
Equally weighted three factor formula
Double weighted sales factor
Triple or greater weighted or single sales factor*Does not address industry-specific or optional formulas
AK
HI
ME
VTNH MA
NYCT
PA
MD
DE
VAWV
NC
SC
GA
FL
ILOH
IN
MIWI
KY
TN
ALMS
AR
LATX
OK
MOKS
IA
MN ND
SD
NE
NMAZ
COUT
WY
MT
WA
OR
ID
NV
CA
DC
NJ
RI
7
Apportionment Formulas* - 2003
Equally weighted three factor formula
Double weighted sales factor
Triple or greater weighted or single sales factor*Does not address industry-specific or optional formulas
AK
HI
ME
VTNH MA
NYCT
PA
MD
DE
VAWV
NC
SC
GA
FL
ILOHIN
MIWI
KY
TN
ALMS
AR
LATX
OK
MOKS
IA
MN ND
SD
NE
NMAZ
COUT
WY
MT
WA
OR
ID
NV
CA
DC
NJ
RI
8
Apportionment Formulas* - 2009
Equally weighted three factor formula
Double weighted sales factor
Triple or greater weighted or single sales factor*Does not address industry-specific or optional formulas
AK
HI
ME
VTNH MA
NYCT
PA
MD
DE
VAWV
NC
SC
GA
FL
ILOHIN
MIWI
KY
TN
ALMS
AR
LATX
OK
MOKS
IA
MN ND
SD
NE
NMAZ
COUT
WY
MT
WA
OR
ID
NV
CA
DC
NJ
RI
9
Recent Legislation– California
• S.B.X3 15: Enacted 2/20/09; single-sales-factor election, effective Jan. 1, 2011
– Colorado• H.B. 1380: Enacted 5/20/08; single-sales factor adopted,
effective Jan. 1, 2009– Maine
• L.D. 499: Enacted 6/7/07; single-sales factor adopted, effective Jan. 1, 2007
– New York• A.B. 4310-C, S.B. 2110-C: Enacted, 04/09/07; accelerated by
one year the institution of the single-sales factor business allocation percentage formula. Previously, the formula for 2007 was to be weighted at 80% for sales and 10%, respectively, for property and payroll
10
Recent Legislation (Cont.)
– Virginia• H.B. 2437: Enacted 4/08/09; allows elective single-sales factor
apportionment for manufacturers, phased-in from July 1, 2011 through 2014
– Pennsylvania• H.B. 1531: Enacted 10/9/9; increases the weight of the sales
factor to 83% from 70% for taxable years beginning after Dec. 31, 2008, and to 90% in tax years beginning after Dec. 31, 2009
11
Recent Legislation (Cont.)
– New Jersey• (2009) A.B. 4028, S.B. 2910: Phase-in of single-sales factor.
Failed to pass
12
Business Activity Tax Bill And Single-Sales Factor
– BAT: Introduced February 2009, would extend P.L. 86-272 protections:
• To all business activity taxes, not just net income taxes• To all “sales transactions” including services, not just to sales
of TPP• To specified “business activities” (such as business activities
directly related to the taxpayer’s potential or actual purchase of goods or services within the state)
• Codifies nexus/physical presence standard – greater than 14 days
13
Business Activity Tax Bill And Single-Sales Factor (Cont.)
– Single-sales factor shifts weight of tax to out-of-state companies
– Out-of-state companies with no physical presence not subject to tax, even if make substantial sales into jurisdiction
– Economic nexus provisions would be voided
14
Uniform Law Commission Abandons UDITPA Rewrite Project
– Study committee of the Uniform Law Commission (ULC), formerly NCCUSL, voted to abandoned UDITPA rewrite
• Rewrite project garnered little support from state legislators and was strongly opposed by many in the business community
• Dave Hilger, UCL UDITPA study committee chairman, reasoned that although it is clear that UDITPA is outdated and needs to be reformed, there is no reasonable probability that the rewrite effort would result in a product that could be uniformly enacted or would directly promote uniformity
15
Apportionment: Case Law Trends And Developments
16
Apportionment
• Why do we care?– After nexus, apportionment is the question
• Constitutional limitations– Unitary business– Apportionment must be fair– Cannot discriminate– Cannot distort earnings in a state
17
Case Law: U.S. Supreme Court
• Fair apportionment– Internal consistency– External consistency
• Non-discrimination– Must not treat foreign corporations differently
from domestic corporations• Unreasonable distortion
– 14% or less may not be enough– 250% or more should be enough
18
Case Law Trends And Developments:Constitutional Issues
• Fair apportionment and non-discrimination
– Pfizer and Whirlpool v. New Jersey• Is the “throwout” unconstitutional?
– New Jersey Natural Gas v. New Jersey• Is the former “regular place of business” requirement
constitutional?
19
Case Law Trends And Developments:Statutory Issues
• Does the sales fraction include receipts at gross or net?– MDC Holdings v. Arizona
– General Mills v. California
• Is a subsidiary’s business attributed to its parent’sholding company?– NES Group v. Massachusetts
20
Thoughts To Take Away
• What we see?– States are getting more creative– States are following other’s cases and statutes– States are sharing information
• What to do?– Document/support reported apportionment figures– Disclose use of alternative apportionment– Stand your ground against unfair apportionment, discrimination
and distortion
21
Concurrent Material Issues
22
NoticeANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials.
The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
2323
Joyce/Finnigan
• For purposes of inclusion of destination sales in the numerator (or for throwback purposes), who is the taxpayer?– Separate unitary member– Entire unitary group
• California decisions– Appeal of Joyce (1966)– Appeal of Finnigan (I & II) (1990)– Appeal of Huffy (2000) & Citicorp North America (2000)
©2009 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
2424
Joyce/Finnigan (Cont.)• Joyce
– Sales by a combined group member into a Joyce state, where the member does not have nexus or is P.L. 86-272-protected in that state, are EXCLUDED from the combined group’s sales factor in the state
– Sales by a combined group member from a Joyce state destined for a state in which the member does not have nexus or is P.L. 86-272-protected are thrown back and are INCLUDED in the combined group’s sales factor in the state
• Finnigan – Sales by a combined group member into a Finnigan state, where the
member does not have nexus or is P.L. 86-272-protected in that state, are INCLUDED in the combined group’s sales factor in the state
– Sales by a combined group member from a Finnigan state destined for a state in which the member does not have nexus or is P.L. 86-272-protected are thrown back and are EXCLUDED from the combined group’s salesfactor in the state
©2009 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
2525
Joyce/Finnigan (2009)
No tax
No pre-apportionment combined or consolidated returns (DC)
Finnigan
Joyce (Alaska and Hawaii)
No authority
Source: KPMG LLP
©2009 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
2626
Joyce/Finnigan (Cont.)
• Potential issues– Sales made by a combined group member from a Finnigan state
into a Joyce state, where the member (on a separate entity basis) does not have nexus or is P.L. 86-272-protected in the Joyce state are excluded from the combined group’s sales factor in both states!
– Sales made by a combined group member from a Joyce state into a Finnigan state, where the member (on a separate-entity basis) does not have nexus or is P.L. 86-272-protected in the Finnigan state may be included in the combined group’s sales factor in both states!
©2009 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
2727
80/20 Rules
• 80/20 Rule– Include foreign incorporated entity in combined group if the entity
has 20% or more of its factors in the U.S. – Note the different rules
• 20% of the average of property, payroll and sales– E.g. California, Illinois, Massachusetts
• 20% of the average of property and payroll– E.g. Colorado, North Dakota, Vermont
• No 20% rule– E.g. New York, Kansas
©2009 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
2828
Sales Factor: Sourcing of Services (2009)
No tax
Benefit or market approach
Service performed in date (%)
Income-producing activity/costs of performance approach (AK, DC, HI)
Other
Source: KPMG LLP
©2009 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
2929
Sales Factor: Market Sourcing RulesState Sourced to state if
CA To the extent the purchaser of the service received the benefit of the service in CA
GA Customer has regular place of business in GA or if benefit of service received in GA
IA Benefit of service received in IA
IL/MN Services are received in IL/MN and taxpayer has a fixed place of business; otherwise, if customer office from which services (1) ordered or (2) billed is in IL/MN
MD Principal impetus for sale is in MD; or, if no state with principal impetus, then if domicile is in MD
ME Services received in ME; or, if this is not determinable, then if customer office or home is in ME
MI Benefit of service received in MI
OH Services used or benefit of is received in OH (location of use or receipt)
UT Purchaser of the service receives a greater benefit of the service in UT than in any other state
WI Purchaser receives the services in WI. Different sourcing rules for services related to RP, TPP, businesses and individual.
©2009 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
30
Resulting Planning Issues, Part I
31
Combined Reporting: Pros And Cons
• What is combined reporting?– A method of filing a corporate income tax return for a group of
affiliates conducting a unitary business– The income and expenses of the members are combined and
apportioned to the taxing state based on a combined apportionment percentage
– The combined group can include entities that do not have nexus with the taxing state on a stand-alone basis
– In theory, only the nexus members are subject to the taxing state’s jurisdiction (i.e., can be liable for the taxes due on the combined report); the non-nexus members’ income/expenses and apportionment factors are used solely to compute the state income tax liability of the nexus members
– NOTE: The portion of this presentation related to the pros and cons of combined reporting is based on an article by Ann Holley and Marie Evans entitled “The Pro’s and Con’s of Combined Reporting: A Compendium of Arguments For and Against Combined Reporting” to be published in an upcoming edition of The Tax Lawyer: The State and Local Tax Edition, an ABA Publication.
32
Combined Reporting: Pros And Cons (Cont.)
• Consolidated reporting is different– Each member of the consolidated report computes its own income
and apportionment; only the post-apportionment income/loss is combined
– Mandatory consolidation requires that each member have nexus; elective consolidation may include non-nexus members that elect to join the group
– Members are typically jointly and severally liable for the tax– A state may use the term “consolidation” when it really means
“combination,” and vice versa• Factors sparking debate
– Since 2004, at least seven states have passed combined reportinglegislation (none had been passed in the prior 20 years)
– Growth of tax minimization strategies combined with state budgetary shortfalls
33
Combined Reporting: Pros And Cons (Cont.)
• Simplistically, whether you are a taxpayer or a state, one may take the view for or against combined reporting based on whether the alternative provides the better outcome– Taxpayer: Does it pay more or less tax?– State: Does it collect more or less income tax revenue?
• While financial effects are central to the debate, other factors are often discussed– Minimizing opportunities for tax planning– Accurately measuring in-state activity– Compliance and administrative effects– Impact on economic development
34
Combined Reporting: Pros And Cons (Cont.)
• Minimizing opportunities for tax planning– Those in favor of combined reporting typically identify tax
planning as an argument in favor of combined reporting– The most common example of a tax planning technique that is
typically nullified by combined reporting is the PIC holding intangible assets
• In a combined reporting state, the income of the PIC and the expense of the operating company would be combined, thus negating the effect of the planning
– Revenue shortfalls have increased awareness in these types of tax planning approaches
– Opponents argue that combined reporting is not the proper way toaddress revenue shortfalls
• No clear evidence that combined reporting increases state revenue• Estimates are not reliable• Other ways exist to counter tax planning (i.e., expense disallowance
statutes)
35
Combined Reporting: Pros And Cons (Cont.)
• Accurate measurement of in-state activity– Proponents of combined reporting argue:
• Better measures the amount of income of a unitary business attributable to a state, when the unitary business in conducted by more than one legal entity
• Companies are free to structure business in a way that makes the most sense from a legal and business perspective; combined reporting is tax-neutral
– Opponents respond:• Separate reporting with arm’s length pricing is an accurate
measurement (may even be better)• Combined reporting creates its own distortions• Legal entity structure can still affect tax computation in Joyce
states and based on the ability to share NOLs and credits
36
Combined Reporting: Pros And Cons (Cont.)
• Effects on compliance and administration– Opponents point to added complexity
• Transition issues– State: Training, promulgating new rules and regulations,
and developing systems from processing new returns– Taxpayer: Costs to learn and understand rules, and need to
create financial data gathering systems• Increase in costs to both sides due to greater number of entities
under audit and issues to be examined• Increased compliance costs to taxpayers for preparing returns• Difficulty in determining “unitary group”
– Proponents basic retort is that combined reporting is nothing new, and most multi-state taxpayers are probably preparing at least one combined report
• Also lessens need to states to audit certain issues, such as transfer pricing
37
Combined Reporting: Pros And Cons (Cont.)
• Impact on economic development– This is really an empirical debate– Opponents rely on evidence that combined reporting increases a
taxpayer’s effective state tax rate, triggering redistributions of capital and jobs among states
• Also point out that worldwide combined reporting affects relations with foreign governments and negatively affects international economic policy
– Proponents point to their own evidence that state taxes play an insignificant role in the business decisions made by taxpayers
38
Establishing The Right To Apportion• In order for a taxpayer to be able to apportion its business income, it
must establish with the taxing state that it has the right to apportion such income
• This right is particularly important in the context of the trend toward single-sales-factor apportionment
• A state with single-sales-factor apportionment provides an incentive to a business to situate all of its assets and employees in that state, since it will have no effect on tax liability with that state
• But, if the right to apportion is not established, that business will pay 100% of its income to the single-sales-factor state– Example: Company A situates all of its assets and employees in
State A, a single-sales-factor state. It has customers and makes sales of tangible personal property to States B, C, D and E via interstate commerce (e.g., UPS delivery). Company A has to report 100% of its income to State A
39
Establishing The Right To Apportion (Cont.)
• So, what must requirement(s) must the taxpayer meet to establish the right to apportion?
• Under the MTC, a taxpayer has the right to apportion if it is “taxable in another state” (MTC Reg. IV.3.(a))
• A taxpayer is “taxable in another state” if it meets either of the following two requirements (MTC Reg. IV.3.(a).(1)):– By reason of its business activity in another state, the taxpayer is
subject to one or more of the following:• Net income tax• Franchise tax measured by net income• Franchise tax for the privilege of doing business• Corporate stock tax
– By reason of such business activity, another state has jurisdiction to subject the taxpayer to a net income tax (regardless of whether it does in fact)
40
Establishing The Right To Apportion (Cont.)
• “Subject to tax” (MTC Reg. IV.3.(b))
– Requirements• Taxpayer carries on business activity in the state; and• State imposes a tax on such activity
– Voluntary minimum tax payments do not work if the taxpayer:• Does not actually engage in business in the state, or• Does actually engage in business, but the minimum tax bears
no relationship to business activity– Other taxes may satisfy if they are viewed as a substitute for an
income tax (i.e., they are revenue raising taxes as opposed to regulatory measures)
41
Establishing The Right To Apportion (Cont.)
• “Jurisdiction to tax” (MTC Reg. IV.3.(c))
– When the taxpayer’s business activity is sufficient to give the state authority to impose a net income tax on such taxpayer under the Constitution and statutes of the U.S.
– If protected by P.L. 86-272, then no jurisdiction– “State” can mean a foreign country, assuming U.S. jurisdictional
standards applied; treaty provisions are ignored– Big question: What is the jurisdictional standard for state net
income taxes under the U.S. Constitution?• Physical presence – Quill• Economic presence – MBNA (West Virginia) – see changes to
W.V. apportionment statute effective 6/6/08 (W. Va. Code §11-24-7(c))
• Use of intangibles – Lanco (New Jersey)
42
Establishing The Right To Apportion (Cont.)
• When determining taxability in another state for purposes of establishing the right to apportion in the taxing state, which state’s jurisdictional standards apply?– MTC and most states do not clearly specify, but case law makes
clear that analysis is based on taxing state’s laws– Two choices
• The taxing state (most states apply this rule) – see Tenn. Code Ann. § 67-4-2010(a) (“A taxpayer is considered taxable in another state only if the taxpayer is conducting activities in that state that, if conducted in Tennessee, would constitute doing business in Tennessee and would subject the taxpayer to either Tennessee's franchise tax or excise tax.”)
• The “other” state – see Cal. FTB Notice (Aug. 16, 1988) (“The law of the destination state, including judicial and administrative interpretation of P.L. 86-272, will be applied in determining whether or not the taxpayer is subject to tax in that state.”)
43
Establishing The Right To Apportion (Cont.)
• Some states do not adopt the MTC– New Jersey had its own rule regarding the right to apportion; only
taxpayers that maintained a “regular place of business” outside the state had the right to apportion (see N.J. Stat. Ann. § 54:10A-6)
• That provision was repealed effective for privilege periods beginning on or after July 1, 2010 (see Assembly Bill A2722, signed Dec. 19, 2008)
– Georgia is not an MTC state and only permits apportionment if taxpayer has business income derived in part from “property owned or business done outside this state” (see O.C.G.A. § 48-7-31(b)(2))
• Habersham Mills, Inc. (1975) – “Whether a corporation is subject to the taxing jurisdiction of other states, as we read our statutes on this subject, is immaterial.”
44
Establishing The Right To Apportion (Cont.)
• Takeaways– The trend toward single-sales-factor apportionment presents
opportunities for taxpayers to minimize effective state tax rate(create “nowhere income”)
– Accomplishing that objective requires that taxpayers and their advisors understand that the right to apportion is crucial
– What the right to apportion means often depends on state interpretations of what constitutes nexus under the U.S. Constitution
– As state interpretations continue to evolve, consider the impact this may have on whether a taxpayer in that state has the right to apportion
45
Resulting Planning Issues, Part II
46
Contribution of manufacturing operations and
personnel
Sales Company
Contribution of sales operations and personnel
Parent
ManufacturingCompany
Tax-Efficient Supply Chain Management: Contract
Manufacturing
47
Sale of product
Sale of product with “right to use”
intangibles
Parent
ManufacturingCompany
Tax-Efficient Supply Chain Management: Contract Manufacturing (Cont.)
Third-party customers
Purchase of materials
Vendors
Sales Company
Sale of product
48
Overview– A newly created subsidiary, Manufacturing Company, sells products to
Parent at an arm’s-length cost plus mark-up– Parent sells products to a newly created subsidiary, Sales Company, on an
arm’s-length basis– Products sold with embedded “right to use” intangibles– Sales Company sells the products to third parties
Benefit– Manufacturing Company and Sales Company have high apportionment
factors but will have reduced income, based on the profit earned by parent– Parent retains the majority of the profits as a result of “owning” the “right
to use” intangibles related to the products sold – Parent has a low effective state tax rate
Tax-Efficient Supply Chain Management: Contract Manufacturing
(Cont.)
49
Parent
Warehouse/Distribution Co
Contribution of warehouse and
distribution operations and
employees
Tax-Efficient Supply Chain Management: Enhanced
Warehouse/Distribution Company
Store Co
Contribution of Store operations and employees
50
Parent
Warehouse/Distribution Co
Sale of products
Tax-Efficient Supply Chain Management: Enhanced
Warehouse/Distribution Company (Cont.)
Store Co
Sale of products with “right to
use” intangibles
VendorsCustomers
Sale of product
51
Overview:• Warehouse/Distribution Co will purchase products from various vendors and
sell the product to parent
• Simultaneous to the sale to parent, the Store Co purchases the inventory from parent at a cost-plus mark-up and resells it to the ultimate customer
• Since parent retains the right to use certain valuable business assets and functions, it makes the sale to the Store Co at a substantial mark-up over its costs
• Parent earns a majority of the group’s taxable income; however, it will have significantly reduced state income tax liability, since it is located in tax favorable jurisdictions
• Warehouse/Distribution Co and the Store Co will have high apportionment factors but will have engineered minimal income
Tax-Efficient Supply Chain Management: Enhanced Warehouse/Distribution
Company (Cont.)
52
Sale of goods with “right to
use” intangibles
Parent
Tax-Efficient Supply Chain Management: Purchasing/Logistics
Company
Vendors
Customers
Purchasing Co
Purchase of materials
Sale to customers
53
Overview:– Parent isolates its purchasing and logistics functions and related assets in a
separate legal entity, Purchase Co
– Purchase Co will purchase goods from various vendors and sell the product to parent
– Since Purchase Co has risk of loss and retains the right to use certain of the company’s intangible assets (i.e., those related to the purchasing function), it makes the sale to parent at a substantial mark-up over its costs
– Purchase Co will earn a majority of the group’s taxable income; however, it will have significantly reduced state income tax liability since it is located in tax favorable jurisdictions (i.e., unitary)
– Parent will have high apportionment factors but minimal income
Tax-Efficient Supply Chain Management: Purchasing/Logistics
Company (Cont.)
54
Parent
Vendors
Customers
Advertising/Marketing Co
Purchase of products
Sale to customers
Sale of products with “right to
use” intangibles
Tax-Efficient Supply Chain Management: Advertising/Marketing
Company
55
Tax-Efficient Supply Chain Management: Advertising/Marketing
Company (Cont.)•Parent purchases the inventory from Advertising/Marketing Co at a cost-plus mark-up and resells it to the ultimate customer
•Since Advertising/Marketing Co retains the right to use certain valuable business assets and functions and provides value-added activities (marketing) to the assets, it makes the sale to the parent at a substantial mark-up over its costs
•Advertising/Marketing Co will earn a majority of the group’s taxable income; however, it has significantly reduced state income tax liability since it is located in tax favorable jurisdictions
56
Alternative Apportionment
• UDITPA Sec. 18 provides:“If the allocation and apportionment provisions of this Act do not
fairly represent the extent of the taxpayer’s business activity in this state, the taxpayer may petition for or the tax administrator may require, in respect to all or any part of the taxpayer’s business activity, if reasonable: (a) separate accounting; (b) the exclusion of any one or more of the factors; (c) the inclusion of one or more additional factors which will fairly represent the taxpayer’s business activity in the state; or (d) the employmentof any other method to effectuate an equitable allocation and apportionment of the taxpayer’s income.”
57
Alternative Apportionment (Cont.)
• Most states have enacted equitable adjustment provisions
• Typically only applied in unique and non-recurring instances where use of the standard apportionment formula produces an inequitable result
• Taxpayer typically petitions for relief and often must prove that the formula is distortive
58
Alternative Apportionment (Cont.)• In Letter of Decision, Appeal of Argonaut Group, Inc. (Jan. 23,
2009), the California State Board of Equalization concluded that the taxpayer had demonstrated that application of the standard apportionment formula to its non-insurance business led to a grossly distorted result and that the alternative apportionment provisions could be applied
• The corporation owned several insurance company subsidiaries. For the previous six years in question, the corporation generated over $165 million in federal taxable losses and still paid over $6 million in gross premium taxes. Because of the distortion caused by the standardapportionment formula, the company would have had to pay an additional $3.5 million in California corporate taxes because 100% of the income of the California non-insurance company was apportioned to California. This was true even though all the insurance activities took place outside of California. The SBE agreed that the corporation had demonstrated distortion