Source: https://www.thetaxadviser.com/issues/2013/mar/redenour-salt-mar2013.html
Timestamp: 2019-04-20 06:46:41+00:00

Document:
By Craig Ridenour, CPA, and Brian Kirkell, J.D.
Alternative apportionment is a statutory device that provides taxpayers and tax administrators with a means to obtain ad hoc relief when the application of a state’s standard apportionment formula fails to reflect a taxpayer’s business activities in the state. It has its roots in a series of U.S. Supreme Court cases that established a narrowly applied constitutional analysis that provided for substantive limitations designed to ensure that practicality and certainty were not sacrificed in favor of fairness in apportionment cases, except in the most egregious circumstances. However, because state statutes that permit alternative apportionment and administrative and judicial interpretations of these provisions are ambiguous, many of these constitutional limitations were not carried over to the states in their individual alternative apportionment statutes.
The narrow application of these constitutional limitations has in recent years resulted in more frequent use of alternative apportionment by both taxpayers and tax administrators, which, in turn, has caused many states to place significant obstacles in the path of taxpayers seeking the benefits of alternative apportionment. Consequently, taxpayers are often faced with an inequitable apportionment outcome with no way to achieve relief from that result in a practical, certain manner. As a means to correct this problem, perhaps the statutory alternative apportionment analysis should be shifted back toward its constitutional progenitor.
This ad hoc relief is intended to ensure fairness when a state’s standard apportionment formula yields the most egregious and nonsensical results, while requiring a high burden of proof and placing other limitations on a challenging taxpayer acknowledges “the practical impossibility of a state’s achieving a perfect apportionment of expansive, complex business activities” 6 and the importance of tax certainty as a policy consideration.
If Not Gross Distortion . . .
Although California’s two-pronged test, as applied thus far, is not perfectly suitable for all instances in which a taxpayer or tax administrator might seek to use alternative apportionment, it provides greater certainty and fairness than the “method” applied by Tennessee and New York, and is a start toward a workable uniform standard for determining when the standard apportionment formula has unfair results.
The problem with this three-factor approach is that it is nothing more than a requirement that the alternative apportionment formula meet the internal consistency and external consistency tests with scant attention to uniformity. This creates substantial uncertainty, since it is highly subjective and leaves open the possibility that an alternative formula will be considered reasonable as long as it does not result in gross distortion. Applying California’s two-pronged test would relieve some of these concerns.
And the Burden of Proof Is . . .
However, because constitutionally required alternative apportionment and alternative apportionment based on fairness are analytically different, there is a question whether the Supreme Court’s other limitations on the judicial doctrine of alternative apportionment apply in a situation where a taxpayer or tax administrator is making an extra-constitutional argument. In general, state courts have placed the burden of proof on the party seeking alternative apportionment 20 and have set that burden at a high level. 21 However, a recent decision by the Indiana Supreme Court calls this approach into question by holding that the tax administrator’s notice of proposed assessment was “prima facie evidence” of the assessment’s validity. 22 This holding creates a nearly insurmountable presumption in favor of the tax administrator if an audit report is, in and of itself, prima facie evidence; thus, in effect, this shifts the burden of proof to the taxpayer, which would not benefit from the lower standard.
The burden of proof standards should be the same for both sides; Indiana’s prima facie evidence rule upsets that balance. It is inherently inequitable and encourages the tax administrator to apply alternative apportionment through the audit process regardless of whether the standard apportionment formula is unfair and the proposed alternative method is reasonable. If more states follow in Indiana’s footsteps, alternative apportionment on a taxpayer-by-taxpayer and year-by-year basis could replace standard apportionment, signaling the death knell of certainty. 23 The Indiana approach should not be applied elsewhere.
Alternative apportionment under the constitutional standard is limited in application but flexible as to timing. An argument for constitutional alternative apportionment can be asserted on an original or amended return, at audit, or on appeal. As long as a taxpayer meets its filing deadlines, state law cannot curtail the taxpayer’s access to the constitutional remedy. However, when a taxpayer cannot prove gross distortion and a taxpayer seeks to use alternative apportionment on another basis under a state’s alternative apportionment scheme, timing could become crucial.
A number of states, generally through administrative guidance, have put into place substantial precertification requirements that limit a taxpayer’s right to use an alternative apportionment formula for original returns and, even then, only with the express permission of the tax administrator. 24 Other states require a taxpayer to file a petition requesting to use an alternative apportionment formula prior to the due date of the original return, file the original return applying the standard apportionment formula, and then file an amended return claiming a refund. 25 Further, some state courts have held that a taxpayer that fails to comply procedurally forfeits its right to alternative apportionment. 26 Finally, these limitations may impair a taxpayer’s ability to assert a different alternative apportionment formula as an affirmative defense against a tax administrator’s use of alternative apportionment on audit.
These kinds of purely mechanical bars against taxpayers’ making an alternative apportionment argument, without similar bars against the tax administrator, operate to limit taxpayer accessibility to alternative apportionment and ignore the equitable principles that underlie alternative apportionment without demonstrably improving certainty or practicality. A better path would be to limit or eliminate mechanical boundaries against taxpayers that assert an alternative apportionment argument, and to put taxpayers and tax administrators on an even playing field in terms of timing.
The Constitution requires a tax on interstate commerce to be fairly apportioned. Although a state’s standard apportionment may generally pass constitutional muster, it may fail to achieve a fair result for a particular taxpayer. In this situation, alternative apportionment may be applied to achieve an equitable result without substantial sacrifice to tax certainty or practicality. However, alternative apportionment has moved from Supreme Court judicial doctrine to state statutory authority, and limitations on alternative apportionment have shifted from being evenhanded to strongly favoring aggressive application of the doctrine by state tax administrators. As a result, the level of fairness achieved by applying the doctrine has waned, tax certainty has suffered, and the practicality of the doctrine has been impaired. These problems can best be restored by shifting the applicability of the doctrine back toward its constitutional roots.
1 Hunt-Wesson, Inc. v. Franchise Tax Bd., 528 U.S. 458 (2000). See also International Harvester Co. v. Evatt, 329 U.S. 416 (1947); Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977); and Container Corp. of Am. v. Franchise Tax Bd., 463 U.S. 159 (1983).
2 Id. See also Oklahoma Tax Comm’n v. Jefferson Lines, Inc., 514 U.S. 175 (1995); Hans Rees’ Sons Inc. v. North Carolina, 283 U.S. 123 (1931).
3 Container Corp., 463 U.S. at 169.
4 Jefferson Lines, 514 U.S. at 185.
5 Moorman Mfg. Co. v. Bair, 437 U.S. 267 (1978), citing Hans Rees’ Sons, 283 U.S. at 135, and Norfolk & Western R.R. Co. v. Missouri State Tax Comm’n, 390 U.S. 317 (1968).
6 International Harvester Co. v. Evatt, 329 U.S. 416 (1947), citing Illinois Cent. R.R. Co. v. Minnesota, 309 U.S. 157 (1940).
8 Pierce, “The Uniform Division of Income for State Tax Purposes,” 35 Taxes 747, 781 (1957). As a primary drafter of UDITPA, Pierce, in his official commentary, provides a great deal of insight into the intent of the drafters in writing UDITPA.
9 Id. at 749. See also Multistate Tax Commission Memorandum, Proposal to Amend MTC Model Regulation IV.18.(A) to Expand Permissible Application of Equitable Apportionment Formulas Under UDITPA Section 18 (3/9/07).
10 See, e.g., Twentieth Century-Fox Film Corp. v. Department of Rev, 700 P.2d 1035 (Ore. 1985); Montana Dep’t of Rev. v. United Parcel Serv., 830 P.2d 1259 (Mont. 1992); Union Pacific Corp. v. Idaho State Tax Comm’n, 83 P.3d 116 (Idaho 2004). But see Unisys Corp. v. Pennsylvania, 812 A.2d 448 (Pa. 2002), in which the Pennsylvania Supreme Court held that the state’s alternative apportionment statute merely allowed the tax administrator to challenge the application of the state’s statutory apportionment formula, and that, in all other ways, the constitutional analysis was undisturbed. See also Fla. Admin. Code §12C-1.0152 and 86 Ill. Admin. Code §100.3390(c), both of which require gross distortion to support applicability of their respective state alternative apportionment statutes.
11 Union Pacific Corp., 83 P.3d at 122.
13 BellSouth Advertising & Pub. Corp. v. Chumley, 308 S.W.3d 350 (Tenn. Ct. App. 2009).
14 N.Y. Dep’t of Tax. & Fin. TSB-A-02(3)C (4/18/02); TSB-A-09(8)C (6/16/09). But see JRS Distrib. Co. v. Department of Treas., LC No. 09-000107-MT (Mich. Ct. App. 2012), in which the Michigan Court of Appeals declined to allow the tax administrator to apply a population factor in lieu of standard sales sourcing.
15 Microsoft Corp. v. Franchise Tax Bd., 39 Cal. 4th. 750 (Cal. 2006). See also Montgomery Ward LLC v. Franchise Tax Bd., No. GIC802767 (Cal. Super. Ct. 2007) (minute order); The Limited Stores, Inc. v. Franchise Tax Bd., 62 Cal. Rptr. 3d 191 (Cal. Ct. App. 2007); Square D Co. v. Franchise Tax Bd., Dkt. No. CGC 05-442465 (Cal. Super. Ct. 2007); and General Mills v. Franchise Tax Bd., 172 Cal. App. 4th 1535 (2009).
16 Microsoft Corp., 39 Cal. 4th. 750, finding that quantitative distortion exists when business income and gross receipts from an activity represent 2% of total business income and 73% of total gross receipts, and operational profit was 167 times greater than profit from the activity in question. But see Appeal of Home Depot, SBE-298683 (Cal. State Bd. of Equalization 12/18/08), which ruled that quantitative distortion did not exist where the activity represented 6.6% of total gross receipts, and operational profit was 18 times greater than profit from the activity in question.
17 General Mills, 172 Cal. App. 4th 1535.
18 Twentieth Century-Fox Film Corp., 700 P.2d at 1044.
19 Unisys Corp., 812 A.2d 448.
20 See, e.g., Twentieth Century-Fox Film Corp., 700 P.2d at 1042.
23 This result would be particularly painful for public companies, which would be hard-pressed to justify not reserving for possible alternative apportionment risks even when filing using the standard apportionment method.
24 See, e.g., Cal. Franchise Tax Bd. Notice No. 2004-5 (Aug. 6, 2004), requiring a taxpayer to obtain prior approval from the FTB before filing a return using an alternative apportionment formula. See also Mich. Comp. Laws §§206.667(1) and (4).
25 See, e.g., N.M. Admin. Code §3.5.19.9.
26 See, e.g., Sidney Frank Importing Co. v. Michigan Dep’t of Treas., No. 383623 (Mich. Tax Trib. 10/5/11). But see Media General, Inc. v. South Carolina Dep’t of Rev., 694 S.E.2d 525 (S.C. 2010); and Carmax Auto Superstores West Coast, Inc. v. South Carolina Dep’t of Rev., 725 S.E.2d 711 (S.C. 2012), both of which held that, in response to a request for, or imposition of, an alternative apportionment formula, a party could affirmatively assert that another alternative apportionment formula is more reasonable.
Jamie Yesnowitz is a principal with Grant Thornton LLP in Washington, D.C., and is the firm’s State and Local Tax—National Tax Office practice leader. Craig Ridenour is a partner, State and Local Tax, with McGladrey LLP in Raleigh, N.C. Brian Kirkell is a director, Washington National Tax, with McGladrey LLP in Washington, D.C. Mr. Yesnowitz is chair and Mr. Ridenour is a member of the AICPA State & Local Tax Technical Resource Panel. For more information about this column, contact Mr. Ridenour at craig.ridenour@mcgladrey.com.

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