Opinion ID: 1161101
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Heading: Whether Internal Revenue Code Section 883 Exempts OBS's Foreign Shipping Income from Taxation by Alaska

Text: The Alaska Net Income Tax Act (ANITA), AS 43.20.011-43.20.350, taxes a corporation's entire taxable income ... derived from sources within the state. AS 43.20.011(e). When OBS filed its 1981-88 Alaska tax returns, it excluded from its tax base all income derived from vessels owned by the foreign subsidiaries in its unitary group. In doing so, OBS reasoned that AS 43.20.021(a) had incorporated subsection 883(a)(1) [3] of the federal Internal Revenue Code (IRC), codified at 26 U.S.C. § 883(a)(1), into ANITA, and that section 883 exempted foreign shipping income. Alaska Statute 43.20.021(a) incorporates sections of the IRC into the ANITA and the Multistate Tax Compact (MTC), AS 43.19.010-43.19.050, [4] unless the IRC provisions are excepted to or modified by other ANITA provisions. [5] The sections adopted by reference encompass IRC section 883. DOR disallowed the exemption, finding that OBS had not proven that its foreign shipping income was exempt from OBS's apportionable tax base. Reversing, the superior court held that AS 43.20.021(a) had incorporated subsection 883(a)(1) into Alaska law, thus exempting OBS's foreign shipping income. DOR contends on appeal that subsection 883(a)(1) is excepted to or modified by the ANITA, given differences in the methods employed by the State of Alaska and by the federal government for determining taxable income. [6] OBS argues that Alaska's income tax scheme is entirely consistent with the section 883 exemption. [7] This is not the first time we have considered whether Internal Revenue Code provisions, ostensibly adopted by reference by AS 43.20.021(a), were excepted to or modified by other ANITA provisions. In Gulf Oil Corp. v. State, Department of Revenue, 755 P.2d 372, 380 (Alaska 1988), we held that a portion of the IRC dealing with the foreign tax credit was excepted to or modified by AS 43.20, which allowed neither a deduction nor a credit for foreign income taxes. In so holding, we noted that [t]hat is not to say that Alaska law incorporates no Code provisions and no federal regulations having to do with the foreign tax credit. Future cases may reveal that it is desirable to conform our law to certain aspects of those federal provisions. Id. The source of the exception in Gulf Oil was the absence in AS 43.20 of any provision for a deduction similar to that provided by the IRC. In this case, we must decide whether the tax scheme employed by the ANITA implicitly excepts to or modifies application of section 883. We first compare the different methodologies applied by the United States and the State of Alaska to determine taxable income. When a state seeks to tax the income of a multinational business, it must determine the income properly allocable to in-state activities. Id. at 374. At all relevant times, Alaska has employed the worldwide formula apportionment method to calculate a multinational or interstate corporation's income earned in Alaska. AS 43.20.065; AS 43.19.010, art. IV, ¶ 9. Under that method, in-state income is determined by multiplying a corporation's worldwide income by an apportionment fraction. AS 43.19.010, art. IV, ¶ 9. [8] A taxpayer's apportionment fraction is the numerical average of three factors  its property factor, its payroll factor, and its sales factor  which compare its in-state business activities with its worldwide business activities. [9] The United States does not utilize the formula apportionment method when it calculates the federal taxable income of multinational corporations. Instead, it uses sourcing provisions to allocate income to the United States or to other sources, depending upon where the income is earned. 26 U.S.C. §§ 861-65; see also 26 C.F.R. § 1.861-1 (1996). Income that cannot reasonably be sourced to the United States is deducted from the taxpayer's gross income and is not included when a taxpayer's U.S. income is calculated. Id. There is consequently a fundamental difference in the way these governments calculate the taxable income of a multinational corporation. Alaska accomplishes its calculation by applying to all income an apportionment fraction that separates the local income from that earned elsewhere. The key to proper separation under this method is the apportionment fraction; it is in the calculation and application of this fraction that the separation is made. In comparison, the United States makes this separation when it first allocates income to sources inside and outside the United States. OBS and DOR agree that Alaska's adoption of the worldwide apportionment method in AS 43.19 establishes an exception to IRC sections 861 through 865, which relate to the sourcing of income for tax purposes. They disagree, however, about whether IRC section 883, which is contained in the same IRC subchapter, is a sourcing provision. OBS claims and the superior court held that it is not, because it grants an exemption, and consequently there is nothing in AS 43.20 that excepts to adopting IRC section 883 into Alaska's corporate tax scheme. The ANITA does not expressly except to or modify the provisions of IRC section 883. Nonetheless, the scheme of allocation and apportionment provided in the MTC, AS 43.19, is fundamental to the ANITA in the context of taxation of taxpayers with foreign income. See AS 43.20.065. [10] Several circumstances convince us that, in the context of OBS's claim that its foreign shipping income should be exempted from taxation in Alaska, subsection 883(a)(1) is impliedly excepted to by the ANITA. We first note that the MTC provides a comprehensive methodology for the allocation and apportionment required by the ANITA, AS 43.20.065. As seen above, the key to that methodology is the apportionment fraction. In our view, it is inconsistent with the MTC, and therefore the ANITA, to exempt an entire class of foreign-earned income from the taxpayer's worldwide income for purposes of attempting to distinguish between locally taxable and nontaxable income. Under the MTC, this separation is accomplished through the application of the apportionment fraction, not the calculation of worldwide income. The legislative history of section 883 demonstrates that it was enacted to eliminate the `double taxation' of shipping income. M/V Nonsuco, Inc. v. Commissioner of Internal Revenue, 234 F.2d 583, 587 (4th Cir.1956) (citing S.Rep. No. 275, 67th Cong., 1st Sess. (1921), 1939-1 (Part 2) C.B. 181, 191). The danger of multiple taxation in that context arises because multinational shipping activities subject the taxpayer to taxation by more than one nation. Avoidance of multiple taxation is the same purpose served by the MTC through the apportionment fraction. DOR contends that allowing the section 883 exemption would have the effect of doubly protecting foreign shipping income. It reasons that because the denominator of a taxpayer's apportionment fraction is based on the value of all property, sales, and payroll, wherever and however derived, the inclusion of the values relating to foreign-flag vessels when calculating those factors under AS 43.19.010 art. IV, ¶¶ 9, 10, 13 & 15, reduces the apportionment factor. If section 883 also applied, thus reducing the taxpayer's worldwide income, it would cause a further reduction when the already-reduced apportionment fraction is multiplied by the newly reduced worldwide income. DOR concludes that this result would understate the taxpayer's Alaska taxable income. We agree that this would be the effect of granting the section 883 exemption. It is also significant that the ANITA contains a statute that appears to deal specifically and comprehensively with the problem of multiple taxation of foreign or multistate water transportation carriers. See AS 43.20.071. That statute provides for apportionment of all business income of water transportation carriers in accordance with the MTC's apportionment formula methodology by modifying the property, payroll, and sales factors from which the apportionment fraction is calculated, by applying a days-in-port fraction. [11] This method further reduces the three statutory MTC factors, and thus the MTC's apportionment fraction. The result is a reduction in taxable income. OBS argues that AS 43.20.071 is compatible with statutory exemptions like that provided by section 883, because section.071 simply applies the apportionment method for water transportation carriers after their apportionable tax base is determined by eliminating exempt income. We reach a contrary conclusion. We think the reference in AS 43.20.071(a) to all business income of water transportation carriers is more consonant with finding the section 883 exemption inapplicable. Reading all business income at face value suggests that it encompasses all income of a business origin, without reduction for any class of income of foreign origin. Further, it appears that in the federal scheme, section 883 uses separate accounting methodology to avoid the problem of multiple international taxation of transportation carriers by assigning income to a source through reciprocal exemptions. The days-in-port ratio adopted by AS 43.20.071 avoids multiple taxation of transportation carriers by formula apportionment. As DOR argues in its reply brief, Alaska has no need to incorporate a reciprocal exemption to avoid possible unfair double taxation of foreign or domestic vessels. More fundamentally, there is no reason to think that the legislature which adopted AS 43.20.071 to provide for sophisticated adjustments to the MTC apportionment fraction, specifically to prevent multiple taxation of water transportation carriers, contemplated that any other unspecified adjustments would be needed to avoid misallocation of this class of business income. [12] OBS argues that the exemption provided by section 883 is not inconsistent with AS 43.20.011, which taxes the entire taxable income of every corporation derived from sources within the State. It also argues that section 883 income can be earned either within or outside Alaska waters, and that AS 43.20.011, which geographically limits taxation to income derived from sources within the State, operates alongside and independently of section 883. It similarly interprets AS 43.20.065 to provide for apportionment of income after reductions for applicable exemptions. OBS also argues that section 883 is not inherently incompatible with the general apportionment provisions of the MTC, and notes that DOR does not object to applying other exemptions, such as IRC section 103, which exempts interest. DOR responds that provisions such as section 103 do not have the effect of assigning income to a foreign or domestic source, unlike section 883. We agree with that distinction. We conclude that the arguments for finding that AS 43.20 impliedly excepts to section 883 are stronger than those to the contrary. [13] If we were to accept OBS's position, it would inevitably result in understating OBS's Alaska taxable income in a way not intended by the Alaska legislature.