State Tax Snapshot: Ruling Brings Alternative Apportionment Controversy into Sharper Focus


Richard Pomp, the hearing officer for the March 28 public session regarding a proposal to change allocation and apportionment provisions in the Multistate Tax Compact, released his report Oct. 25 on the proposed amendments. Pomp, a professor at the University of Connecticut School of Law, analyzed the impact of such changes as modifying key terms such as “business income,” clarifying rules for obtaining an alternative apportionment formula, and replacing the cost-of-performance sourcing method with one based on market-based sourcing.

Also included among the revisions Pomp considered were changes to Section 18 of UDITPA, which addresses alternative apportionment. The proposal would allow states to adopt alternative apportionment rules for taxpayers involved in a particular industry, transaction, or activity. To accomplish this, the committee suggested adding language to the current alternative apportionment provisions which would clarify each state's authority to impose special regulations as well as ad hoc deviations in special cases.

A dozen states indicated in Bloomberg BNA’s 2013 Survey of State Tax Departments that they have issued no written guidance addressing when the state or taxpayer can invoke an alternative apportionment method. These states were Alabama, Arizona, Colorado, Delaware, Kentucky, Maine, Michigan, Mississippi, North Dakota, Pennsylvania, Rhode Island, and Utah.

Pomp’s report also concluded that the burden of proof should rest with the party requesting alternative apportionment.

However, in an Oct. 21 BBNA webinar (which will be re-broadcast on Nov. 14), Shirley Sicilian, general counsel for the MTC, said the party bearing the burden of proof should depend on whether a state tax department has issued an assessment. “The question is whether the Section 18 alternative apportionment determination is part of that up front assessment of what the taxpayer owes to the state, and not something separate and outside of that,” she said.

Sicilian noted during the webinar that in Mississippi and Indiana, recent case law has shown that once the department has assessed the tax, the burden shifts to the taxpayer. She suggested the department could take this position because the taxpayer holds all the information as to whether an alternative apportionment formula would be appropriate.

During the webinar, Pomp questioned whether taxpayers should be penalized for following the statutory apportionment formula, when the department later determines that the formula distorts their income. “What is the behavior we want to punish, following a statute?” Pomp asked.

Pomp said the notion of taxpayers trying to anticipate changes that will be later made by the tax agencies “seems unreasonable and unfair.”

A case that brings the problems surrounding alternative apportionment into sharp focus is Equifax Inc. v. Miss. Dep't of Revenue, No. 2010-CT-01857 (Miss. 2013), Pomp said at the webinar.

In Equifax, the taxpayer, a service company that was registered to do business in Mississippi, had employees located in the state, and had roughly $22 million in Mississippi gross receipts. The company used the state's standard costs of performance apportionment formula for service companies to calculate its in-state business income. Upon audit, the department determined that the state's statutory apportionment formula—which the taxpayer had complied with—distorted the taxpayer's business activity in the state.

The department recalculated the taxpayer's income using an alternative, market-based sourcing apportionment method and issued a revised tax assessment, but also added penalties and interest, even though the taxpayer had timely filed its tax returns and had properly computed its in-state business income according to the department's own regulations. 

The court ruled that the burden of proving the unreasonableness of the department's decision to use an alternative method fell to the taxpayers, and having failed to carry that burden, the department acted within its authority to require taxpayers to use an alternative apportionment method to effectuate an equitable allocation of income. The court further upheld the imposition of penalties because the taxpayer had likewise failed to meet its burden of proving the penalties were not reasonable.

Do you agree with Pomp's conclusion regarding alternative apportionment? Share your opinion in the BBNA State Tax LinkedIn Group.

By  Melissa Fernley and Steven Roll

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