In Corporate Executive Board v. Virginia Department of Taxation, the Circuit Court of Arlington County ruled in favor of the Virginia Department of Taxation (the Department) and held that Corporate Executive Board (CEB) failed to demonstrate that it was entitled to use an alternative method of apportionment. This ruling clarifies the burden taxpayers must meet when seeking to use an alternate means of apportionment to determine Virginia income tax liability.
Background – Where Should Sales be Sourced?
CEB’s main source of income was derived from its sales of subscriptions, which provided customers online access to data and information developed by CEB. The data and information accessed by CEB’s customers was primarily developed by CEB in Virginia; however, the majority of CEB’s sales of subscriptions were to customers outside the state.
Virginia uses a three-factor formula of property, payroll, and double-weighted sales to apportion income, pursuant to Va. Code 58.1-406 through 58.1-420. CEB, which had the burden of proof to show that the standard formula did not accurately reflect its Virginia-source income, claimed that the use of this method was unconstitutional and inequitable, and sought to use an alternative apportionment formula to better reflect its income in Virginia.
CEB’s alternate apportionment formula sourced sales based on the addresses of the subscribers (the “destination-based” sourcing method), or where the transactions occurred. CEB also claimed that the use of the statutory sourcing method resulted in double taxation, based on other states applying destination-based sourcing to the same sales.
The Department claimed that the production activity of the data and information occurred in Virginia, so the subscription sales should be sourced to Virginia. CEB requested that the Tax Commissioner use its alternate destination-based sourcing method to source its sales outside of Virginia, which the Tax Commissioner denied.
CEB subsequently paid its tax liability based on the statutory apportionment method, and filed a claim for a refund. In its refund claim, CEB alleged that the application of the statutory apportionment method caused it to pay significantly more tax than the tax to which Virginia was constitutionally entitled.
Consistency – The Standard for Constitutionality
Apportionment formulas must be fair under the Due Process and Commerce Clauses, and such fairness is determined by using the internal and external consistency tests. The internal consistency test requires that the use of the same apportionment formula by every state not result in double taxation of any income. The external consistency test requires that each state’s tax only reach the portion of value attributable to economic activity within the state.
The court found that the use of the statutory apportionment formula satisfied both tests. Virginia’s apportionment formula was internally consistent because the apportionment formula only considered in-state factors in determining the amount of tax. The court also found that it was reasonable to attribute the sales income to economic activity in Virginia, because the data and information was primarily created, developed, improved, and stored in Virginia, satisfying the external consistency test.
In addition, the court found that the use of CEB’s proposed method would not accurately reflect income and would lead to an arbitrary result, as customers were not required to use any of the data or information CEB provided at their addresses, or even at all.
Tax Commissioner’s Denial of Relief Not Inequitable
The court also found that the use of the statutory apportionment formula was not inequitable, and that the Tax Commissioner did not act in an arbitrary, capricious, or unreasonable manner, or otherwise abuse his discretion in denying CEB’s refund claim.
For the use of Virginia’s statutory apportionment formula to be inequitable, it must produce double taxation attributable to Virginia. Because only factors attributable to Virginia were considered when using the statutory apportionment formula, and Virginia did not consider benefits other states or markets realized, there was no double taxation.
Next, the Tax Commissioner did not act arbitrarily or abuse his discretion in this case because a taxpayer is not entitled to use a different apportionment formula as a matter of course. CEB failed to meet its burden to show why it should be entitled to use a different formula because it primarily presented policy-based reasons to support the request and policy is for the state legislature—not the courts—to consider when determining the state’s apportionment formula.
Because CEB failed to establish that the statutory apportionment formula was unconstitutional or inequitable, the court did not address whether CEB’s alternate apportionment formula would better reflect its income in Virginia.
Continue the discussion on the BBNA State Tax Group on LinkedIn: Did CEB meet its burden and show that it was entitled to an alternate method of apportionment?
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