Oregon within the 'range of permissible interpretations'

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.

North Carolina: reducing tax rates, phasing-in single sales factor apportionment and considering market-based sourcing

North Carolina enacted budget legislation which reduces the corporate income tax rates, adopts a 100% sales factor for apportionment, and increases the minimum and maximum amounts under the franchise tax. In addition, some taxpayers may be required to file an information report with their 2015 tax return to help the state determine whether to adopt market-based sourcing.

Corporate Tax Rate

Effective for tax years beginning on or after January 1, 2016, the tax rate for C corporations is decreased from 5% to 4%. The tax rate will be decreased further to 3% if the amount of net general fund tax collected in a fiscal year exceeds $20.975 billion.

Sales Factor for Apportionment

North Carolina is phasing in a 100% sales factor. Currently, the sales factor is double-weighted. Effective for tax years beginning on or after January 1, 2016, the sales factor will be triple-weighted. Effective for tax years beginning on or after January 1, 2017, the sales factor will be quadruple-weighted. Effective for tax years beginning on or after January 1, 2018, only a sales factor will be used for apportionment.

Taxpayers May Be Required to File Informational Report for 2015 Tax Year

The Revenue Laws Study Committee is directed to study the calculation of the sales factor using market‑based sourcing. To help the Committee determine the effect of market‑based sourcing on corporate taxpayers, each corporate taxpayer with apportionable income greater than ten million dollars ($10,000,000) and a North Carolina apportionment percentage less than one hundred percent (100%) is required to file an informational report with the Department of Revenue.

As part of its 2015 income tax return, each corporation required to file an informational report will be required to show the calculation of the taxable year 2014 sales factor using market‑based sourcing.

Franchise Tax

Effective January 1, 2017 for taxes due on or after that date, the franchise tax will be calculated on net worth. Currently, it is calculated on issued and outstanding capital stock, surplus, and undivided profits. The minimum tax was increased to $200 from $35 and the maximum tax was increased to $150,000 from $75,000. 

From H.B. 97, Sections 32.13, 32.14 and 32.15

collaborating with Bloomberg BNA on new state tax analysis tool

Working in the state tax field for 20+ years, I have experienced companies using all kinds of excel spreadsheets for what-if planning, tax provision analysis, quarterly estimates, and tax audit response. Some have worked well, and others, not so much. If your company or your clients are looking for a new tool, I suggest you check out the BNA State Tax Analyzer by Bloomberg BNA.

The BNA State Tax Analyzer is the industry first and only multi-state, multi-year, multi-scenario state tax analysis tool for corporate income tax. It is a cloud-based solution that delivers a full-audit trail, permissions control, and automatic tax-law updates. In fact, I collaborated (and continue to collaborate) with Bloomberg BNA’s software products group to ensure that state tax law (back to 2000) and recent legislative changes are integrated into the product.   

Some of the features include:

  • Out-of-the-box calculations, with built-in tax rules and rates for all states that have a corporate income tax, plus the District of Columbia
  • Familiar grid approach fits into your current work style
  • Audit trail shows who did what when, giving you the SOX controls you need
  • Permissions control protects your work
  • Customized computations allow you to handle special industry calculations
  • Side-by-side comparisons let you see the difference between two scenarios or total across multiple scenarios
  • Flexible reporting basis allows you to switch between combined/unitary, consolidated, and separate entity reporting as needed

With its comprehensive set of calculations and audit trail capabilities, BNA State Tax Analyzer can complement or replace risky, time-consuming spreadsheets – saving tax departments hundreds of hours of time and effort every year.

  • Take complexity and risk out of corporate state tax calculations
  • Gain greater insight with reserve planning for ASC 740 analysis
  • Ensure accuracy of state tax returns
  • Accelerate tax audits
  • Demonstrate compliance with thorough documentation

To learn more, visit here.     

Tennessee issues guidance regarding nexus and apportionment

Tennessee's 2015 franchise and excise tax guide provides additional information that companies operating inside and outside Tennessee should review and plan accordingly in advance of 2016.

  1. Economic nexus standard - expanding criteria under which an out-of-state vendor may incur nexus
  2. Apportionment formula - changed apportionment formula by triple-weighting the sales factor
  3. Market-based sourcing - additional information and clarification regarding application of market-based sourcing for sales other than tangible personal property
  4. Distribution apportionment incentive - special elective apportionment rule for taxpayers who sell very large volumes of product to regional distribution

Economic Nexus Standard

For tax years beginning on or after January 1, 2016, out-of-state businesses not already subject to Tennessee taxes will be subject to franchise and excise taxes to the fullest extent allowed by the Constitution. Such nexus includes, but is not limited to, any of the following:

  • The taxpayer is organized or commercially domiciled in Tennessee;
  • The taxpayer owns or uses its capital in Tennessee;
  • The taxpayer has a systematic and continuous business activity in Tennessee that has produced gross receipts attributable to customers in Tennessee; or
  • The taxpayer has a bright-line presence in the state. A person has a bright-line presence in this state for a tax period if any of the following applies:
    • Receipts: > $ 500,000 or 25% of total receipts from sales in TN
    • Property: > $ 50,000 or 25% of total property by value in TN
    • Payroll: > $ 50,000 or 25% 

Triple-Weighting of Sales Factor

For tax years beginning on or after July 1, 2016. the apportionment formula consists of the property factor, plus the payroll factor, plus three times the receipts factor, and the denominator is five (5).

Market-Based Sourcing

For tax years beginning prior to July 1, 2016, sales of other than tangible personal property are allocable to Tennessee if a greater proportion of the earnings-producing activities are performed in Tennessee. Effective for all tax years beginning on or after July 1, 2016, sales, other than sales of tangible personal property, are in Tennessee if the taxpayer’s market for the sale is in Tennessee. (see page 52 of the guide for details on when the taxpayer's market is in Tennessee)

Distribution Incentive

Effective January 1, 2016, a taxpayer that meets the gross sales threshold and the receipts factor threshold (one billion dollars or the taxpayer's receipts factor exceeds 10%) during the tax period qualifies for the application of a new distribution incentive and may elect the incentive by filing an election form with the Department on or before the due date of the tax return for the period for which such election is to take effect. The election remains in effect until revoked by the taxpayer or until the taxpayer no longer qualifies for the election.

"Certified distribution sales" means sales of tangible personal property made in Tennessee by the taxpayer to any distributor, whether or not affiliated with the taxpayer, that is resold for ultimate use or consumption outside the state; provided, that the distributor has certified that such property has been resold for ultimate use or consumption outside Tennessee. (see page 53 of guide for details on when the incentive applies)

 

states change interpretation without any change in law?

Throughout my career I have faced several instances where states have made audit assessments or taken positions under audit that contradict the position the state has taken in the past when it has audited the company.  This change in position by the state has occurred even when there has been NO CHANGE in the state's statutes, rulings and court cases since the last audit.

Should the state be able to change their position without any change in authority?  In most cases I would say no.  Unfortunately, when you challenge the position within the audit, you may not get anywhere.  You may have to go to appeals or even court to resolve.  My experience is that resolution is highly likely at the appeals level (this obviously depends on the facts of each case).

With that said, getting back to my original question, should a state be able to change its position without any change in authority?  Allowing states to do so causes a taxpayer to incur time and money to challenge the change in position, when there is no reasonable basis for the change.  

Why would a state make an assessment when there is no change or basis for the assessment?  Well, the answer may be that the state has changed its policy or interpretation of a statute or regulation.  The state may believe that this change in interpretation is enough.  It may or may not be, depending on the facts of the case.

Overall, if you run into this situation don't just accept it.  Question it.  Challenge it.  Just remember, you may have to go to appeals to resolve the matter.  

DISCLAIMER:  Each case is different and states may have justification for their change in position.  This is a reminder to not just accept the change, but to seek to clearly understand the state's position so you can determine if you should challenge it. 

the first day . . . . . "elbows and knees"

Today is the first day of school for my daughters. One is a sophomore in high school and the other is starting middle school. I know for some of you, school started weeks ago. Well, regardless of when, the situation is the same. We all go through the preparation, the planning, the registering, the fee-paying, school supplies and clothes shopping, etc. Then the day draws closer, the last day of summer dawns, the night before comes. After all of the preparation, the reality of new classes, new teachers, new schools, new friends, tests and quizzes sets in. A little anxiety (or a lot) comes to mind. That's when we pray. We trust. 

As my daughters start back today, I have the innate feelings of my responsibility. My natural instincts and priorities are to: provide, protect and lead. These are my objectives and my role in my family. As most parents, we seek to provide for our families. Provide them not only with material things, but with love, confidence, self-worth and a place of serenity so they can grow to be strong and independent. We want to provide them with opportunities and freedom to pursue the gifts and talents that were given to them. 

We also want to protect them. I can't tell you how strong this emotion is in me. Maybe it's because I have daughters, but I would do anything to protect them. I have a phrase that I created and I tell my girls, "elbows and knees." It stands for two things. One, the elbows and knees are the hardest parts of your body. Use them to defend yourself physically if necessary. Second, it is a philosophy for life. Many things in our lives will push us down. Will attempt to discourage and make us feel less than. The road to achieving our dreams and goals will be difficult (if the dream is worth pursuing); thus, we must be willing to do the work. To dig in. To fight back against a world that seems to push. We must use our "elbows and knees."

Last but not least, we must lead our families. We cannot rely on the world, the schools, church or the government to teach our kids how to live, how to treat others, how to achieve, how to love, etc. That is our jobs as parents. 

How does this relate to state taxes?

Well, state tax compliance, audits or planning can sometimes cause anxiety. That's when we are instincts to provide, protect and lead our companies and tax departments must kick-in. We must use our 'elbows and knees' to stand. To fight for what we know is right. To dig deeper. To have wisdom to discern when to fight and when to walk away.