Tax Executives Institute – NJ
Chapter
Current Issues in
Apportionment
Gary C. Bingel
bingel@amper.com
Stephen J. Bercovitch
bercovitch@amper.com
Contents:


Constitutional Background
Issues with Apportioning Sales Other Than Those from
the Sale of Tangible Personal Property

Alternative Apportionment Relief

Apportionment Issues with Flow-through Entities
Constitutional Background

Due Process Clause – concerned with fundamental
fairness and notice:
 Must be some minimal connection (“slightest
presence”) between the state and activities the state is
seeking to tax (including the taxpayer itself); and
 Must be a rational relationship between the income
attributed to the interstate and intrastate values of the
entity.
Constitutional Background

Commerce Clause
 Must be “substantial nexus” with the state
 Tax must be fairly apportioned
• Internal consistency test


Tax must not discriminate against interstate commerce
Tax must be fairly related to the services provided by
the state and how income is earned.
• External consistency test
Overriding Constitutional Questions

When evaluating apportionment formulas, the following
should always be included in the thought process:
 Is the income being taxed rationally related to the
value connected with the state and the benefits
received?
 Are material income-producing factors excluded or
disproportionately weighted?
 Discrimination?
Apportioning Receipts Other than from the
Sale of TPP
Alternative Apportionment Relief

UDITPA Section 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
for or the tax administrator may require, in respect to all
or any part of the taxpayer’s business activity, if
reasonable:
• Separate accounting
• The exclusion of any one or more of the factors
• The inclusion of one or more additional factors which will
fairly represent the taxpayer’s business activity in this
state, or
• The employment of any other method to effectuate an
equitable allocation and apportionment of the taxpayer’s
income.
Alternative Apportionment Relief



Contrast UDITPA’s “business activity” language (CA, NJ,
NY, PA) with other states (CT, DE, MD) that reference a
taxpayer’s “income.”
 Language often interchanged – E.g. MD’s statute
references a taxpayer’s income, while the regulation
references business activity.
 Some states use “or” language (business activity or
income). E.g., NJ & NY
Differences between locations of a company’s “business
activity” and where “income is earned.”
Some states provide for only the state to seek an
alternative method and not the taxpayer (MD).
Alternative Apportionment Relief

Current Application:
 Single Factor Constitutionality?
• Moorman Mfg. Co. v. Blair, 437 U.S. 267 (1978)
• This case was NOT decided under current internal /
external consistency framework, which didn’t come
into place until five years later in Container Corp. of
America v. FTB, 463 U.S. 159 (1983).
• Case was also decided primarily on the failure to
establish a base against which single-factor could be
measured.
Alternative Apportionment Relief

Current Application
 Single Factor / Heavily Weighted Receipts / Throw-back
/ Throw-out
• Do these formulas reasonably reflect how income is
earned? External consistency?
• Are a company’s property and payroll irrelevant to how a
company earns its income? Aren’t they a significant
measure of a company’s “business activities?”
• Why do the laws of another state effect how your income
is earned in another state?
• Are these formula’s discriminatory?
• Look to statements of legislators!
Alternative Apportionment Relief

Recent Case:
 In the Matter of Infosys Technologies, Ltd, NY tax App
Tribunal (2/21/08):
• India-based software firm was not allowed to utilize a
separate accounting method to calculate its income for NY
purposes, and was required to use worldwide income as
its tax base.
• The use of an alternative receipts factor was also denied.
• Taxpayer was allowed to adjust its payroll factor based on
the ratio of NY billable employees to total billable
employees, due to disparate pay rates between NYC and
India.
Alternative Apportionment Relief

Sword Cuts Both Ways:
 Even if you follow a state’s statutory guidance, the
state may use these same arguments to alter your
apportionment calculation.
• Microsoft Corp. v. FTB, CA Supreme Ct. No S133343. 39
Cal.4th 750) (8/17/06) and other treasury function
receipts cases.
• In Microsoft, even though gross receipts marketable
securities transactions may be properly included in the
receipts factor, such inclusion would be distortive.
Therefore, the apportionment formula was modified to
include only the net proceeds in the receipts factor.
Alternative Apportionment Relief

How do you Obtain Relief?
 Some states have defined methods of seeking relief:
• NY & NJ – Require pre-approval from the Dept of Rev.
Taxpayer must file report using statutory formula. A
request to vary the formula must be attached, along with
the related computation and reasons for the variance.
• MD – separate accounting permitted “if practicable.”
• PA requires a taxpayer to “petition” the department for
use of an alternative formula. However, no further
guidance is given.

For other states it is often not clear how relief is
sought.
• File, file and disclose, disclose through amended return?
Alternative Apportionment Relief

Timing?
 Is pre-approval required before utilizing alternative
formula?
• CA / NY / NJ all require taxpayer to receive approval
before the filing date of the return.
Alternative Apportionment Relief

Other Issues for Obtaining Relief:
 Establishment of Baseline
• Most cases are decided based on the inability to establish
a proper baseline (See, e.g., Unisys v. PA, 812 A.2d 448
(10/25/02)), but how is such a baseline determined?
• Use of economists?
• Separate Accounting?

Burden of Proof?
• Clear and Convincing?
• Other?
Flow Through Entity Issues

Many more states are taxing flow-through entities directly:
 OH
 MI
 TX
 NH
 TN
 Phila
 NYC
Flow Through Entity Issues

Threshold question – is there jurisdiction to tax the owners
of flow-through entities under the Due Process Clause?
 The owners of flow-through entities are legal entities
separate and apart from the pass-through entities
themselves. Thus, a question exists as to whether
under the Due Process Clause a state can require an
owner to treat income from a flow-through entity as
apportionable income absent a unitary relationship.
• One factor to consider is whether flow-through treatment
was elective (eg, S corps).
• Is there limited liability?
• Does the flow-through serve a purely investment
function?
• Is ownership less than 50%
Flow Through Entity Issues

Assuming the jurisdiction has the right to tax the owners,
how are apportionment factors calculated?
 Flow-through of all factors? (Typical treatment)
• Unitary relationship? Some states (e.g., CA) require a
flow-through of factors when a unitary relationship exists.
• Other special rules; e.g., previously IL did not deem
second tier partnerships unitary and thus did not flow-up
factors more than one level.
• Elimination of intercompany transactions with
partnership? IL DOR Ruling IT 08-0001-PLR (5/19/08)


Distributive share as gross receipt?
Specific allocation of pass-through income
• LA / MS / OK all require partnership income to be
specifically allocated based on where earned.
Flow Through Entity Issues

Determination of Business / Non-business Income
 At the partnership level – IL
 At the partner’s level – PA
 Most states don’t address
Flow Through Entity Issues

Calculation of Throw-back / Throw-out and Joyce /
Finnigan issues:
 Is the determination made at the partnership level or
the partner level when determining sales to be thrown
back / out?
• Joyce states – each entity’s apportionment factors are
calculated independent of the others, and then combined.
Thus, a partnership’s sales to a state where it doesn’t
have nexus may be subject to throwback despite the fact
that the corporate partner has nexus in such state.