State Tax Snapshot: The Top 3 Corporate Income Tax Developments in 2013

The world of multistate corporate income tax in 2013 was focused on questions surrounding the Multistate Tax Compact in the wake of California’s 2012 Gillette decision, the continued shift toward market-based sourcing, and rising frustration over alternative apportionment.

Highlighted below are the top 3 developments in multistate corporate income taxation. (For an in-depth look at all of these issues, check out Grant Thornton’s SALT Top Stories of 2013).

Reactions to Gillette. 2013 marked an off year for Gillette, which was decided in 2012 and will be heard by the California Supreme Court in 2014 (GilletteCo. v.California Franch. Tax Bd., 147 Cal. Rptr. 3d 603 (Cal. Ct. App. 2012); petition for review granted, 291 P.3d 327 (Cal. 2013)).  

In Gillette, the taxpayer sought to avoid using the state’s double-weighted sales factor apportionment formula and elected to use the three-factor formula specified in the Multistate Tax Compact. But the court ruled that such an election was not available. In short order, the California legislature removed the state from the Multistate Tax Commission’s Compact.

The case has spawned litigation on the same issue in Michigan, Texas and other states. The District of Columbia, Oregon, Utah, Minnesota, and South Dakota enacted legislation in 2013 that repealed all or some portions of the Multistate Tax Compact.

Market-Based Sourcing.As more states are relying on a single sales factor apportionment formula, the manner in which taxpayers must source their sales receipts is an issue of growing importance. Over the past few years, several states have moved away from the cost of performance approach, which sources receipts from sales of services or intangibles to the jurisdiction in which most of the costs were borne.  These states have adopted a market-based sourcing approach, which attempts to reflect the taxpayer’s market share within the jurisdiction’s borders. Massachusetts and Pennsylvania enacted legislation that will require taxpayers to use a market-based approach for certain transactions beginning in 2014.

Alternative Apportionment. Taxpayer uncertainty concerning basic aspects of state rules for imposing or requesting an alternative apportionment formula continues. In 2013, 12 states said they lacked written guidance on alternative apportionment, according to the Bloomberg BNA 2013 Survey of State Tax Departments. Taxpayer frustration about this issue became especially acute in 2013 in reaction to previous hitEquifaxnext hit Inc. v. Miss. Dep't of Revenue, No. 2010-CT-01857 (Miss. 2013).

In that case,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.

What were some of the other top corporate income tax developments in 2013? Continue the discussion on Bloomberg BNA’s State Tax LinkedIn Group.

By Steven Roll

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