Corporate Close-Up: Are Throwback Rules Distortive? Illinois Tax Tribunal Says ‘No’

When dealing with interstate sales of tangible personal property, states generally want to make sure that every transaction is being taxed. Most states that impose a corporate income tax use destination based sourcing for receipts from sales of tangible personal property, meaning that the receipts are sourced to the state where the property is delivered to the purchaser. However, this creates a problem: what happens to the receipts from tangible personal property shipped to states that will not tax the sale? Do companies get a free pass on these receipts?

As noted in the Bloomberg BNA Survey of State Tax Departments, about half of all states have enacted throwback rules to solve this problem. Under the throwback rules, receipts from sales of tangible personal property are included in the numerator of the sales factor of the state’s apportionment formula if the sales originate in the state and the sales would be attributable to a state in which the corporation is not subject to tax. 

In Innophos Holdings v. Ill. Dept. of Rev., Illinois faced a challenge in the Illinois Independent Tax Tribunal to its calculation of the sales factor through the use of the throwback rule. Innophos, a manufacturer of phosphates used in food, pharmaceutical and industrial markets, argued that the Department of Revenue could not automatically include throwback sales in its apportionment formula because of a 2013 amendment to Illinois’ alternative apportionment rules. Innophos argued that this change meant that the state bore the burden of showing that the throwback sales should be included to accurately reflect the taxpayer’s connection to Illinois.

The department countered that inclusion of throwback sales in the sales factor of the apportionment formula is automatic, and that nothing in the changes to the alternative apportionment statute altered this requirement. The department further pointed out that if Innophos had believed that the formula did not accurately reflect its income from Illinois it could have petitioned for alternative apportionment.

On Nov. 17, the Tribunal found in favor of the department, saying that Illinois was entitled to add throwback sales to the sales factor numerator. Under a reading of the plain and ordinary meaning of the statute, the throwback rule is unambiguous, and the Illinois legislature intended the automatic inclusion of throwback sales in the numerator of the sales factor. Innophos contended that the alternative apportionment rules under 35 ILCS 5/304(f), which allow for petition for alternative apportionment for tax years ending on or after Dec. 31, 2008 if standard apportionment does not fairly represent the market for the taxpayer’s goods, preclude the automatic inclusion of these sales because throwback sales should not automatically be considered part of the Illinois “market” for its sales.

However, the Tribunal found this argument unpersuasive, noting that the change in language from “business activity” to “market” in the alternative apportionment statute coincided with Illinois shift from cost-of-performance sourcing for sales not of tangible personal property (including services and intangible property) to market based sourcing. The language of the throwback rule was not changed in 2013 when the alternative apportionment statute was changed, leading the tribunal to conclude that the legislature intended to continue to automatically include the throwback sales in the sales factor numerator. The court noted that Innophos’ reading of the two statutes would effectively render the throwback rule void, and so rejected this argument.

The tribunal further ruled that Innophos’ contention that the department bore the burden of proof to show that the throwback sales should be included was incorrect. Since the normal apportionment rules include the throwback provision, the burden lay with Innophos, the party challenging the standard formula, to show that it was entitled to alternative apportionment and propose an alternate methodology, which it had not done.

This case presented an interesting challenge to throwback rules: that they are inherently distortive and that state departments of revenue should have to prove that throwback sales should be included in the sales factor before adding them. However, it appears that Innophos would have been better served by timely filing for an alternative apportionment formula, showing the distortion and proposing an alternate method, rather than relying on the courts to take its position and effectively render the throwback rule moot.

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: Are state throwback rules inherently distortive of corporations’ income from business activity in those states?

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