Weekly Round-Up: MTC Adopts Market-Based Sourcing, Amends UDITPA's Other Apportionment Rules

Member states of the Multistate Tax Commission voted to adopt market-based sourcing and other long-awaited revisions to Article IV of the Multistate Tax Compact, which contains the Uniform Division of Income for Tax Purposes Act (UDITPA), during the MTC's annual business meeting on July 30 in Albuquerque, New Mexico.

The amendments, which passed with an 81 percent vote and without discussion or opposition by those present, change UDITPA's apportionment and sourcing provisions by:

• moving from cost-of-performance to market-based sourcing for services and intangibles;
• giving states the option to choose their own factor weighting, but including a recommendation that states double-weight the sales factor;
• expanding the definition and scope of “business income” to all income that is apportionable under the U.S. Constitution; and
• narrowing the definition of sales to exclude hedging transactions and treasury receipts from the sales factor.

The member states did not vote on the proposed amendments to Article IV, Section 18, addressing alternative apportionment. However, the MTC's Uniformity Committee approved revisions to its draft proposal concerning burden-of-proof language included in this section when it convened during the annual meeting on July 28. The  MTC  Executive Committee approved the revisions July 31.

Impact of Amendments

The amendments addressing the sourcing of services and intangibles will likely have the most widespread impact to taxpayers, Jamie Yesnowitz, a principal with Grant Thornton LLP in Washington D.C., told Bloomberg BNA July 30.

But the other amendments are likely to have less of an effect, he said. The expansion of the business (apportionable) income definition to include all amounts that can be classified as such under the U.S. Constitution is not likely to have major effect, as many states consistently challenge most taxpayers' attempts to classify income as nonbusiness income, Yesnowitz said in an e-mail. The factor weighting recommendation of double-weighted sales is unlikely to be heeded by states, which have shown that they want complete autonomy in setting the parameters of their apportionment formula, he added. The changes to the definition of sales (receipts) may be important to certain taxpayers, particularly those that have significant treasury functions and engage in large amounts of hedging and other securities transactions.

“Given the resistance that the Uniformity Committee had demonstrated several weeks ago to the Executive Committee's urging to consider and recommend adoption of these limited measures, it must be a relief to those in the MTC's leadership that saw this outcome as desirable, that it was actually achieved,” said Kendall Houghton a partner with Alston & Bird LLP in Washington D.C. in a July 31 e-mail to Bloomberg BNA. “The amendments will mean a great deal to the compact member states to the extent they move forward and change their laws in response, said Yesnowitz. The amendments provide a template for the states that do not follow the compact, he added. “The commission's action portends even less of a role for the property and payroll factors, and with respect to the sales factor, far more emphasis on the location of a taxpayer's market instead of its people in sourcing items other than the sale of tangible personal property,” Yesnowitz said.

Need for Revisions

The need for revisions to Article IV were first addressed in 2009, but the draft amendments were not approved for public comment until December, 2012.

Over a year passed before the Executive Committee approved the recommend amendments voted on by the member states.

The changes respond in part to criticisms of the Multistate Tax Compact and UDITPA over their treatment of sourcing of income and apportionment of corporate income taxes.

The adoption of the amendments comes after committee members voted March 12 to recommend to the Executive Committee that its draft be adopted instead of the Oct. 25 report by Prof. Richard Pomp, the hearing officer who presided over a hearing into proposed amendments to the MTC compact.

A number of practitioners expressed disappointment that Pomp's recommendations were not adopted. “I think that Professor Pomp spent a considerable amount of time and effort in holding the public hearing on the potential amendments to the Compact, and developing his suggested revisions. I am hopeful that some of the detailed and thoughtful recommendations he made, particularly those with respect to Section 18 which were not adopted by the Commission, will be considered by the Commission in the near future,” said Yesnowitz.

The MTC has been trying to regain support from states—some of which have withdrawn from the compact—by amending Article IV. State revenue directors and corporate taxpayers have been waiting for the California Supreme Court to issue a ruling in Gillette Co. v. California Fran. Tax Bd.

The Gillettecase involves the taxpayer's decision to avoid California's double-weighted sales factor apportionment formula and elect the three-factor formula specified in the compact.

In Gillette Co. v. California Fran. Tax Bd., 147 Cal. Rptr. 3d 603 (Cal. Ct. App. 2012); petition for review granted, 291 P.3d 327 (Cal. 2013), a state appeals court in California ruled that the election was available to allow taxpayers to apportion their in-state income using the compact's formula.

Michigan Ruling

In another case involving the compact, the Michigan Supreme Court recently ruled in Intl. Bus. Machs. Corp. v. Mich. Dept. of Treas.,No. 146440 (Mich. July 14, 2014) that IBM was entitled to use the compact's three-factor formula for apportioning business income when it filed its 2008 taxes, and wasn't required to use the sales-weighted formula contained in the Michigan Business Tax. The court said the compact has remained in effect even as the Michigan Legislature has repealed and replaced business tax statutes without expressly repealing the compact. The Michigan Business Tax Act includes a single sales factor apportionment formula. The court held the compact should take precedence over state law if multistate companies elect to use its three-factor apportionment formula.

Market-Based Sourcing

Many compact member states, as well as other states, have moved to market-based sourcing of services and intangibles. Market-based sourcing is intended to source sales to the state where the taxpayer's market is located.

States that have moved to a market-based system have done so without the benefit of a model act or provision, which has resulted in even less uniformity than there is in the provisions implementing costs of performance, said Joe Huddleston, executive director of the MTC.

During the July 30 meeting, the MTC member states also:

• amended the MTC's public participation policy to reflect the commission's current practices regarding teleconferences;
• renewed Policy Statement 2009–01, Tribal-State Tax Issues; and
• approved a number of honorary resolutions.

Burden-of-Proof Revisions Recommended

The Uniformity Committee, which met July 28, recommended the commission's Executive Committee incorporate a provision addressing proposed amendments to Article IV, Section 18(c) of UDITPA, which concerns apportionment cases involving taxpayers.

Committee members weighed two options on burden of proof, ultimately favoring a provision stating that a state tax administrator shall not bear the burden of proof of imposing a different allocation or apportionment method if the administrator can show that in any two of the prior five tax years, the taxpayer had used an allocation or apportionment method “at variance with its allocation or apportionment method or methods used for such other tax years.”

The  MTC  Executive Committee approved the revisions July 31.

During discussion on the revisions, Executive Committee member R. Bruce Johnson, chair of the Utah State Tax Commission, said it wouldn't be appropriate “for a tax administrator to have to bring the burden of proof” if a taxpayer decides to use an allocation or apportionment method that is different than an earlier agreed-upon method.

“If you have an agreement, and you want to change it, the burden of proof should be on you,” Johnson said.

Also on July 28, the MTC Uniformity Subcommittee on Sales and Use Tax approved an amended resolution encouraging states to adopt the American Bar Association's Model Transactional Tax Overpayment Act, which sets forth uniform transaction tax refund procedures in states.

The agenda for the MTC's annual business meeting, which includes the text of all amendments or resolutions addressed, is available on the Internet at http://www.mtc.gov/Executive.aspx?id=6340.

By Lauren Colandreo and Tripp Baltz

Continue the discussion on Bloomberg BNA’s State Tax group on LinkedIn:   How do you think the adopted amendments will impact taxpayers going forward?

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In other developments…

California – Certain LLC corporate members may not be subject to the state’s corporate franchise tax, by PwC

Texas may soon end its "trailing nexus" treatment for out-of-state sellers, by the Texas State and Local Tax Law Blog

Alabama Tax Tribunal to Issue Proposed Regulations on July 31, by Bradley Arant Boult Cummings LLP

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