Uniform Division of Income for Tax Purposes Act
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Déjà Vu – Marketplace Model Debate May Resume Again

The debate over state marketplace laws may resume again, after the Uniform Law Commission (ULC) announced it has set up a committee to study whether to draft a uniform state law on online sales tax collection, focusing on marketplaces. The study committee is chaired by Utah Sen. Lyle Hillyard. The lead staffer (“reporter”) will be Professor Adam Thimmesch of the University of Nebraska College of Law. The members of the committee are listed here and information to sign up to be notified of developments is available here.

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Indiana Department of Revenue Rules Forced Disposition is Nonbusiness Income

In Letter of Finding No. 02-20140306 (Dec. 31, 2014), the Indiana Department of Revenue (Department) determined that income from the sale of two operating divisions of a business pursuant to an order of the Federal Trade Commission (FTC) was non-business income under Indiana law. Following the reasoning of the Indiana Tax Court in May Department Stores Co. v. Ind. Dep’t of State Revenue, 749 N.E.2d 651 (2001), the Department held that the gain constituted non-business income because the forced divestiture was not an integral part of the taxpayer’s business. Taxpayers facing the consequences of forced divestitures should consider whether similar positions can be taken, both in Indiana and in other Uniform Division of Income for Tax Purposes Act (UDITPA) jurisdictions.

Like many states that base their income apportionment provisions on UDITPA, Indiana defines “non-business income” as all income that is not business income. Indiana employs both the “functional test” and the “transactional test” to determine if a particular item of income qualifies as “business income.” Income may qualify as business income under either test; it is not required that both tests be met.

The functional test considers whether the income derives from the acquisition, management or disposition of property constituting an integral part of the taxpayer’s regular trade or business. Simply put, if a piece of property is used in the taxpayer’s regular course of business, a transaction involving that property will often result in business income. The transactional test, meanwhile, considers whether the income derives from a transaction or activity in which the taxpayer regularly engages.

In the Letter of Finding, the Department considered a taxpayer that sought to acquire, by merger, one of its competitors (“Target”), which consisted of four primary business divisions. The taxpayer and Target were part of a concentrated industry with very few competitors, so the acquisition created antitrust concerns. The taxpayer and Target sought advice from the FTC, which ordered that two of Target’s divisions be sold to a competitor if the merger were to take place. The taxpayer and Target complied with the FTC’s order, and Target sold the divisions to a competitor in 2006, prior to the merger. It classified its resulting income as non-business income. On audit, the Department reclassified the Target’s gain as business income, reducing the taxpayer’s Indiana net operating losses available for use in 2008-2010. The taxpayer appealed.

In examining the transaction, the Department first noted that the income from the sale of the divisions could not meet the transactional test because Target did not engage in the regular sale of business divisions. The Department then turned to the functional test. Arguably, the sale of the two operational business divisions should have resulted in business income because the divisions were used in the regular course of Target’s business. However, the Department observed that this fact alone was not enough to meet the functional test—“[t]he disposition too must be an integral part of the taxpayer’s regular trade or business operations.” Relying [...]

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MTC’s Market-Based Sourcing Recommendations for UDITPA: Too Little, Too Late?

Member states of the Multistate Tax Commission (MTC) voted to adopt proposed amendments to Article IV of the Multistate Tax Compact during their annual meeting in late July.  The proposed amendments likely to have the most widespread impact on taxpayers are the amendments to the Uniform Division of Income for Tax Purposes Act (UDITPA) Article IV section 17 sourcing rules that change the sales factor sourcing methodology for services and intangibles from a costs of performance (COP) method to a market-based sourcing method. 

The MTC’s recommended market approach provides that sales of services and intangibles “are in [the] State if the taxpayer’s market for the sales is in [the] state.”  In the case of services, a taxpayer’s market for sales is in the state “if and to the extent the service is delivered to a location in the state.”  The proposed amendments also provide that if the state of delivery cannot be determined, taxpayers are permitted to use a reasonable approximation.  At this point, there is no additional guidance from the MTC on the meaning of “delivered,” how to determine the location of delivery in the event that a service is delivered to multiple jurisdictions, or what constitutes a reasonable approximation.

While the proposed amendments may be touted by some as the death knell of COP sourcing, for these changes to take effect, they will still need to be adopted individually by legislatures in Compact member states or in any other states that may choose to adopt them.  As we have seen over the last several years, many states have already forged their own paths in this area.  (See our article discussing the wide variety of market-based sourcing rules.)  Moreover, while many states have enacted market-based sourcing provisions with respect to the sale of services, certain states, unlike the MTC proposed amendments, have declined to convert to market-based sourcing for intangibles (e.g., Pennsylvania).

The proposed amendments leave taxpayers with many unanswered questions.  For example, assume a corporate taxpayer (Corporation A) is in the business of offering a payroll processing service.  Corporation A provides this service to Corporation B.  Corporation B’s management of the contractual arrangement with Corporation A occurs in Massachusetts, which is also the location of Corporation B’s human resources function.  Corporation B has 10,000 employees, 2,000 of whom are located in a jurisdiction that has adopted the MTC’s market-based sourcing recommendation (State X).  What portion of Corporation A’s receipts from the performance of its payroll processing service for Corporation B should be sourced to State X?

One can reasonably argue that the service is delivered to Corporation B as a corporation (i.e., that the human resources function is the true beneficiary) and not individually to Corporation B’s employees—leaving State X with nothing.  However, does the MTC’s language “if and to the extent the service is delivered” create an opportunity for State X to argue that it should receive 1/5 (2,000 employees/10,000 employees) of Corporation A’s receipts?

In late August, the MTC launched a project to [...]

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2015 D.C. Budget Bill Includes Several Significant Business Tax Changes

The FY 2015 District of Columbia Budget Request Act (BRA, Bill 20-749) is currently being reviewed by the D.C. Council after being introduced on April 3 at the request of Mayor Vincent Gray. This year’s Budget Support Act (BSA, Bill 20-750), the supplementary bill implementing changes based on the BRA, contains several significant modifications to the tax provisions of the D.C. Code. The changes include provisions recently recommended by the D.C. Tax Revision Commission (TRC), an independent body created by the Council to evaluate possible changes to tax policy in the District with a focus on broadening the tax base and providing “fairness in tax apportionment.” In particular, the BSA proposes to adopt a single sales factor formula for the apportionment of business income and to reduce business income tax rates (both corporate and unincorporated) from nearly 10 to 9.4 percent. Two additional amendments are pulled directly from the Multistate Tax Commission (MTC) rewrite of the Uniform Division of Income for Tax Purposes Act (UDITPA), including a change to the District’s definition of “sale” and the elimination of cost-of-performance sourcing.

Under the District’s existing apportionment statute, all businesses must apportion business income using a four factor formula consisting of property, payroll and double weighted sales factors. If the BSA is enacted, the statute would be amended to also apportion all business income using a single sales factor. While it is clear that the intent of the BSA provision is to adopt a single sales factor in D.C. going forward, a major ambiguity exists in drafting that would require apportionment using both a single sales and double weighted sales factor formula for taxable years starting after December 31, 2014—which of course is impossible. Thus, without a legislative amendments by the D.C. Council prior to passage on May 28, it is unclear whether the single sales factor formula will be optional or mandatory (as recommended by the TRC) for FY 2015. The budget projection released by Mayor Gray in conjunction with the legislation suggests that the single sales factor would be mandatory, since it is projected that this change would raise an additional $20 million in tax revenue for the District for FY 2015. If the single sales factor were optional, it is unlikely the provision would raise that much revenue.

In addition to statutory modifications to the apportionment formula, the BSA also would reduce the tax rate imposed on corporate and unincorporated businesses from 9.975 percent to 9.4 percent.  This is still higher than Maryland (8.25 percent) and Virginia (6 percent).

Picking up where the MTC left off with its ongoing UDITPA rewrite, the District would adopt the MTC draft definition of “sale” to explicitly exclude receipts from hedging transactions and other investment related activity (including the sale, exchange or other disposition of cash or securities).

In addition, BSA would adopt market-based sourcing for sales of intangibles and services, using the language of the MTC draft to do so.  The BSA does not pick up the remaining provisions of the MTC [...]

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