The Oregon Supreme Court's recent decision in AT&T Corp. interprets and applies Oregon's "cost of performance" statute in a manner that produces a market-based sourcing result. In reaching its decision, the Court stated:
"while there is room for doubt at the statutory level, it appears to us that the department’s interpretation of the statute is more likely to be within the range of permissible interpretations."
Consequently, the Department wins and the taxpayer loses.
This case is another example of where the grey area of state tax law creates litigation, and then when litigated, the Court relies on the Department's view because it is reasonable. The Court could have easily ruled in the taxpayer's favor based on the taxpayer's interpretation of the statute.
The parties offered two competing interpretations of what constitutes AT&T’s income-producing activity. AT&T’s interpretation focused on the operation of the network broadly, which was part of its justification for treating network costs as “costs of performance.” The department’s interpretation focused on individual transactions with customers, and that was part of its justification for concluding that network costs should be left out of the “costs of performance” analysis.
According to the Court, Oregon statutes (ORS 314.665(4)) do not look to the market where the sales occur. There is nothing specified about the geographic location of the taxpayer’s customers, which one would expect from a factor focused on a state’s contribution to the market. Instead, the provision looks to where the taxpayer effectively produces the income. The state where the taxpayer conducts its “income-producing activity” for a sale or class of sales may or may not happen to be the market state.
The Court asserts that Oregon statutes seem to connect the term “income-producing activity” with particular “sales.” According to the Court, the statutory purpose is to assign the income from sales to particular states, and to do that, the provision directs taxpayers to identify the activity that produces that income—the income from that particular sale. The statute suggests that the focus may be on individual sales. Such a reading parallels the treatment of sales of tangible personal property. Just as that statute attributes each individual sale of tangible personal property to a particular state, so ORS 314.665(4) arguably attributes other individual sales to a particular state. That would imply, then, (according to the Court) that the income-producing activity means the activity that produces the income associated with a particular sale.
Regardless of the Court's assertions, the Court also declared that this is not the only possible way to read the state's provisions.
"Commentators have routinely criticized UDITPA section 17 for its ambiguity: “[T]he commentators have found the rules to be ‘confusing and indefinite’ and plagued by ‘vagueness,’ ‘ambiguity,’ ‘substantial debate,’ ‘lack of clear guidance,’ ‘whipsaw[ing],’ ‘tremendous flexibility, and hence [tax planning] opportunity,’ ‘frequent litigation,’ ‘inconsistency,’ and ‘confusion for taxpayers and taxing authorities alike.’”"
Despite the criticism and confusion, the Court deferred to the department’s position regarding the meaning of “item of income” because it is "not inconsistent with the text of the rule in its context, or with the statute, or with any other source of law."
As always, the burden is on the taxpayer to prove the Department is wrong. In this case, the burden of proof was on AT&T to demonstrate that it was entitled to a refund. As a practical matter, that means AT&T had to introduce evidence showing that, in connection with its sales of interstate and international voice and data transmission, a greater share of the “costs of performance” for each “income-producing activity” was incurred in a state other than Oregon.
Based on the Department's interpretation and the Court's ruling, AT&T was required to identify the relevant non-network costs for each income-producing activity. In other words, AT&T was required to use a transaction-based interpretation of "income-producing activity." AT&T's cost study did not identify the non-network costs because AT&T had used network-based interpretation of "income-producing activity" implying that network costs counted as direct costs.
ruling opens door for assessments?
The Oregon Supreme Court ruling allows Oregon to utilize market-based sourcing without actually changing its current statutes to impose market-based sourcing. In other words, the interpretation supported by the ruling opens the door for the state to audit taxpayers and make assessments on taxpayers that once felt 'safe' or reasonably certain about their sourcing methodology and subsequent result.
re-examine your sourcing methodology
Taxpayers providing services to customers in Oregon should re-examine their sourcing methodology to determine if the ruling and interpretation will change the amount of sales apportioned to Oregon and ultimately, the taxpayer's tax liability.