As states continue to revise and refine their apportionment formulas, and as businesses continue to evolve, statutory apportionment formulas do not always fairly reflect taxpayers’ in-state activities. This may result in a distortion of the income subject to tax. Therefore, taxpayers must examine the reasonableness of the application of the apportionment formula to their business to ensure they are not being overtaxed. Watch the full webinar presentation of these slides here http://ow.ly/VvvFz.

1. 1
Alternative Tax
Apportionment
Issues Confronting
Multistate Companies

2. Alternative Tax Apportionment Issues Confronting Multistate Companies
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BACKGROUND
Historically, states used separate accounting to determine in-state
income
Apportionment was adopted as separate; accounting was time-
consuming and unreliable
Initial formulas were for property tax purposes and relied solely on a
property factor

3. Alternative Tax Apportionment Issues Confronting Multistate Companies
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PURPOSE OF APPORTIONMENT
Fictional approximation of income earned in a taxable jurisdiction
– Property
– Payroll
– Sales
Tax planner’s role is to determine if the approximation is appropriate

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CONSTITUTIONAL OVERVIEW
Due Process requirements
– States may only tax the income earned within their borders
– The tax must be fairly related to the services derived from the state
 Wisconsin v. J.C. Penney Co., 311 U.S. 435
Commerce Clause requirements
– Tax must be fairly apportioned
 Container Corp. of America v. FTB, SCt, 463 US 159 (1983)
» Internal consistency test—If every state has the same tax and applied it the same
way, no multiple taxation would occur.
» External consistency test—The apportionment formula must actually reflect how
income is generated.

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APPLICATION OF SECTION 18
The standard Alternative Apportionment provision is found in UDITPA
§ 18
– If the allocation and apportionment provisions of this Act do not fairly
represent the extent of the taxpayer’s business activity in this state, the
taxpayer may petition or the [tax administrator] may require alternative
apportionment
The state’s standard apportionment formula when applied to a specific
taxpayer creates an arbitrary or unreasonable result
The application of the apportionment method does not fairly
represent the business activity in the state

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ALTERNATIVE METHODOLOGIES
Separate accounting
The exclusion of any one or more of the factors
The inclusion of one or more additional factors
The employment of any other reasonable method
– Combined reporting
 Media General Communications, Inc. v. South Carolina, (South Carolina Supreme
Court, 2010)
– Inclusion of intangible property in the property factor

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STATUTORY ALTERNATIVE APPORTIONMENT
Industry-specific Alternatives
– Construction
– Transportation
– Financial Services
– Media

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INVOKING ALTERNATIVE APPORTIONMENT
Who may invoke alternative apportionment?
– The state may require the use of an alternative apportionment formula
– The taxpayer may request the use of an alternative apportionment factor
Who has the burden of proof?
– Generally, the party seeking alternative apportionment has the burden
of proof
– Consider:
 Does the burden of proof differ depending on the party seeking a change?
 What impact does the deemed correctness of an assessment have on the
burden of proof?

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INVOKING ALTERNATIVE APPORTIONMENT
Burden of Proof
– Constitutional “Gross Distortion”
 Twentieth Century-Fox Films v. Dep’t of Revenue, 700 P.2d 1035 (Ore. 1985)
» Oregon Supreme Court reviewed whether the Department proved that the statutory three-
factor apportionment formula did not fairly represent the extent of taxpayer’s business
activity in this state, thus permitting the department to employ a different method
» Court held that alternative apportionment is only applicable to remedy unconstitutional
situations or where the UDITPA formula does not fairly represent the business activity of the
taxpayer
 Florida and Illinois – Regulations provide if the statutory formula will lead to“grossly
distorted”results in a particular case; a fair and accurate alternative method is appropriate.
Fla. Admin. Code Ann. §12C-1.0152; 86 Ill. Admin. Code § 100.3390(c)
 Most states have found that the constitutional“gross”requirement is not necessary to
justify alternative apportionment – some lesser standard usually applies

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INVOKING ALTERNATIVE APPORTIONMENT
Preponderance of the evidence, slightly more evidence in support than against
it, >50%
Clear and Convincing/Cogent Evidence. Somewhere between preponderance
of evidence and beyond a reasonable doubt , highly probable. Between 75 and
80% likely
– Moorman Manufacturing Co. v. Blair, 437 U.S. 267
– California – Microsoft v. Franchise Tax Board, 139 P.3d 1169 (Cal. 2006). The party
invoking the alternative formula must prove by clear and convincing evidence
that the statutory formula is not a fair representation. In so holding, the court
adopted a quantitative and qualitative test
– New York – British Land (Maryland) Inc. v. N.Y. Tax App. Trib., 85 N.Y.2d 139, 147-48
(N.Y. Ct. App. 1995). Must demonstrate by clear and cogent evidence that the
standard apportionment formula does not properly reflect a taxpayer’s presence

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ELEMENTS TO BE PROVEN
What level of distortion must be shown in order for a taxpayer or state
to be entitled to alternative apportionment?
– Does the statutory formula not fairly reflect the extent of the taxpayer’s
activities in the state?
– Is the apportionment result out of all appropriate proportion to the
business transacted in that state?
Prove that the proposed alternative method is“reasonable.”
– Does the fact that the statutory formula does not adequately reflect
income earned in the state satisfy the reasonable test?
– If the alternative formula is determined not to be reasonable, but the
statutory method is distortive, what is the result?

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INDICATIONS OF UNFAIR APPORTIONMENT
Use of separate accounting
– Hans Rees’Sons
– Moorman Mfg. Co.
– Rejected in Exxon and Mobil
Separate accounting alone will not support alternative apportionment,
as this was the method withdrawn in favor of formulary
apportionment
– In re: Appeal of Crista Corp. (California State Board of Equalization, No.
2002-SBE-004, June 20, 2002)

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INDICATIONS OF UNFAIR APPORTIONMENT
Factor does not represent income earned in the state
– Treasury receipts
 Microsoft v. FTB, (California Supreme Court, 2006)
Missing factor
– Inventory
 Georgia v. Coca-Cola Bottling Co. (GA Supreme Court, 1956)
– Intangibles
 Microsoft v. FTB, (San Francisco Superior Court Case No. CGC08471260, 3/21/11, case
appealed to the California Court of Appeals)
– Futures contracts
 General Mills Inc., v. FTB, 208 Cal. App. 4th 1290 (2012). In determining whether the
receipts from hedging transactions should be included in the computation of the receipts
factor, the Appellate Court concluded that the FTB did not have to prove the
reasonableness of only one alternative but may, if reasonable, apply any“method that is
reasonable to effectuate an equitable allocation and apportionment of the taxpayer’s
income.”

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UNREASONABLE APPORTIONMENT
Application of the Three-Factor Formula
– Application of the traditional UDITPA three-factor formula can result in
an inaccurate reflection of a taxpayer’s income
– An in-state company with significant property and payroll sourced to the
state can benefit from an equally weighted three-factor apportionment
formula
– In contrast, multistate businesses with little or no payroll or property to
offset their receipts are often at a disadvantage

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UNREASONABLE APPORTIONMENT
Is the inclusion of foreign-source dividend, interest, and royalty income
without appropriate factor representation unconstitutional?
– No – Conoco Inc., v. State of New Mexico, 931 P. 2d 730 (NM 1996)
– Yes – Tambrands, Inc. v. State Tax Assessor, 595 A. 2d 1039 (ME 1991)
– No – E.I. DuPont de Nemours v. State Tax Assessor, 595 A. 2d 1039 (ME
1996), ruling on the“Augusta Formula”which was devised after the
Tambrands case
 The Augusta Formula allows exclusion of 50% of the dividends from foreign
subsidiaries, but without factor relief

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UNREASONABLE APPORTIONMENT
Taxpayer’s use of the statutory formula
– Use of the statutory cost of performance method
 Equifax Inc. v. MS DOR, MS S. Ct. (June 20, 2013)
» June 20, 2013, the Mississippi Supreme Court upheld an assessment, including
penalties, against Equifax for failure to apportion its income using a sales factor
based on its market presence in Mississippi. In that case, the Court did not find it
necessary that the Department of Revenue had the burden to prove that the
statutory method of apportionment, cost of performance, resulted in distortion.
» H.B. 799, enacted April 10, 2014, effective January 1, 2015, clarifies the ability of
the Department of Revenue and taxpayers to utilize alternative apportionment.
» Specifically, the legislation requires the party requesting alternative
apportionment show by a preponderance of the evidence that the statutory
method of apportionment does not fairly represent the extent of a taxpayer’s
Mississippi business activity, and that the proposed method does more fairly
represent the activity more than any other reasonable method.

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UNREASONABLE APPORTIONMENT
Vodafone Americas Holdings, Inc. v. Roberts, No. M2013-00947-COPA-
R3-CV TN Ct. App. (6/23/2014)
– June 23, 2014, the Tennessee Court of Appeals upheld a lower court’s
and revenue agency’s decision to require Vodafone to use an alternative
method of apportionment.
– Vodafone had sourced revenue for the sale of cell phone services to
Tennessee based on the statutory cost of performance rule, where
services are sourced to a single state in which the bulk of the taxpayer’s
cost of performing the service is incurred.
– The Court upheld the Commissioner of Revenue’s decision to use a
market-based sourcing rule to report Tennessee receipts.
– The Court found that the Commissioner had shown by clear and cogent
evidence that unusual circumstances existed to warrant a deviation from
the statutory formula.

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UNREASONABLE APPORTIONMENT
Trend to more heavily weighted sales factor or single-sales factor formula
– Only eight of 19 MTC member states continue to use the equally weighted
three-factor apportionment formula
– Does using a heavily or single weighted sales factor more accurately reflect the
activities of taxpayers conducting business within its borders?
 The rationale is a weighted sales factor corresponds with the technological
advancements (e.g., the generation of sales and other gross receipts does not
necessarily depend on having employees, real property , or tangible property within a
state)
 However a single sales factor only reflects the contribution of the market state
MTC Article III obligates member states to offer their multistate taxpayers the
option of using either the Compact’s three-factor formula to apportion and
allocate income for state income tax purposes or the state’s own alternative
apportionment formula
Due to the adoption of a single sales factor by a number of states, the option to
use the standard three-factor apportionment formula becomes an attractive
alternative method for out-of-state taxpayers

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UNREASONABLE APPORTIONMENT
A California taxpayer was permitted to use the equally weighted three-factor
MTC apportionment formula to calculate its California franchise tax
– Gillette argued that the state’s mandate of apportionment using double-
weighted sales factor violated California’s participation in the MTC
– The California Court of Appeals determined that the Multistate Tax Compact is
binding on the signatory states and that it calls for the option, under UDITPA, to
apportion income on an equally weighted three-factor basis
– The election is necessary to provide a taxpayer an option for uniformity when
there are conflicting state statutes
– The only way for a member state to eliminate this option is to withdraw from the
MTC
– Gillette Co. v. Franchise Tax Board, No. A130803, Court of Appeal of California, First
District (Oct. 2, 2012)
– CA Supreme Court heard oral arguments on this case on October 6, 2015

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MICHIGAN
IBM v. Department of Treasury
– July 14, 2014, the Michigan Supreme Court decides (4 to 3) in favor of
the taxpayer, allowing the election of an equally weighted three-factor
apportionment formula
– September 10, 2014, Legislature approves retroactive repeal of MTC
compact. Governor approves and enacts law on September 12, 2014
– To date, the Michigan court of claims and court of appeals have upheld
the retroactive repeal of the MTC compact. Most recently in Gillette
Commercial Operations N. Am. v. Department of Treasury, MI Ct. App., No.
325258, 9/29/15, the Court upheld the retroactive repeal

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MINNESOTA
Kimberly-Clark Corp. v. Commissioner of Revenue, MinnesotaTax Court,
File No. 8670-R, June 15, 2015
– Court concluded, without deciding, that the MTC compact created a
valid binding contract between Minnesota and the other states that
adopted the compact
– However, the compact did not bar the Minnesota Legislature from
repealing Articles III and IV, to eliminate the equally weighted three-
factor apportionment election
– The court determined that the 1987 repeal of the equally weighted
three-factor apportionment election was permitted under the compact,
and therefore held for the state

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OREGON
In an Oregon Tax Court case, an out-of-state taxpayer is asserting that
it has a right to elect to apportion its income under the Multistate Tax
Compact’s evenly weighted three-factor formula.
The complaint to the tax court’s magistrate division was filed on July 2.
The parties met in a case management conference in August, and on
Sept. 17 filed for a petition of special designation to bypass the
magistrate division and start the proceedings in the regular division.
That petition is awaiting a ruling by the judge.
Oregon adopted the compact in 1967 and is still a full member.
However, in 1993, the state enacted Revised Statute 314.606, which
says that when Oregon enacts an apportionment formula that conflicts
with the Multistate Tax Compact election provision, the state statute is
controlling.
Oregon currently requires single-sales-factor apportionment.
Health Net, Incorporated and Subsidiaries v. Department of Revenue
(Case No. 120649D).

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TEXAS
In orders released by the Texas Controller of Public Accounts on
9/12/12, 5/16/13, 6/18/13 and 8/14/13, denied the refund claims of
three unidentified out-of-state businesses that attempted to elect to
apportion their income under the Multistate Tax Compact’s evenly
weighted three-factor formula.
In the 6/18/13 case, the taxpayer introduced the CA Gillette win into
the record. The Comptroller ruled that no weight can be given to
Gillette as it was depublished, and cert was granted by the California
Supreme Court.
Texas adopted the Multistate Tax Compact in 1967 and is still a full
member, with the compact codified as chapter 141 of the TexasTax
Code. However, Sec. 171.106(a) of the Code requires that a taxable
entity’s margin be apportioned to Texas under a single-factor formula
based on gross receipts.
Texas is a bit more complex than California, as there is a question as to
whether the Texas gross margins tax is an“income tax.”

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REASONABLENESS OF PROPOSED METHOD
Twentieth Century-Fox Films v. Dep’t of Revenue, 700 P.2d 1035 (Ore.
1985)
– Reasonableness has at least three components 1) the division of income
fairly represents business activity and if applied uniformly would result in
taxation of no more or no less than 100% of a taxpayer’s income; 2) the
division of income does not create or foster lack of uniformity among
UDITPA jurisdictions; and 3) the division of income reflects the economic
reality of the business activity engaged in by the taxpayer in the state.
Carmax Auto Superstores West Coast, Inc. v. DOR, SC Supreme Court, No.
27474 12/23/2014
– The party seeking to use the alternate formula need only show that its
accounting method is reasonable, not that it more fairly represents the
taxpayer’s business than any competing method.

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CONCLUSION
Despite taxpayer setbacks in the MTC cases, Equifax, Vodafone, and
others, it is still the taxpayer’s duty to examine the reasonableness of
the application of the apportionment formula to its business.
With the increasing reliance on the sales (market) factor as a way to
solely source income, many taxpayers may find themselves in
situations where the statutory formulas do not reflect a taxpayer’s
presence in a particular jurisdiction resulting in a distortion of the
income subject to tax by that jurisdiction.

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Contact Information
Mark L. Nachbar
Principal
Ryan
State Income and Franchise Tax
mark.nachbar@ryan.com
630.515.0477

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