Voters Approve Temporary Tax Rate Hikes and Mandatory Single Sales Factor Apportionment Formula
At the November 6, 2012 general election, California voters approved temporary increases to the personal income tax and state sales and use tax rates and made the current elective corporation franchise and income tax single sales factor apportionment formula mandatory.
Personal Income Tax Rates
Proposition 30 increases the personal income tax rate for the 2012 through 2018 tax years. The current 9.3% rate (10.3% rate for taxable incomes over $1 million) will be raised by:
- 1% for single individuals with taxable incomes of $250,001 to $300,000;
- 2% for single individuals with taxable incomes of $300,001 to $500,000;
- 3% for single individuals with taxable incomes over $500,000;
- 1% for heads of household with taxable incomes of $340,001 to $408,000;
- 2% for heads of household with taxable incomes of $408,001 to $680,000;
- 3% for heads of household with taxable incomes over $680,000;
- 1% for joint filers with taxable incomes of $500,001 to $600,000;
- 2% for joint filers with taxable incomes of $600,001 to $1,000,000; and
- 3% for joint filers with taxable incomes over $1,000,000.
Sales and Use Tax Rates
Proposition 30 also increases the state sales tax rate by 0.25% for four years. Effective January 1, 2013, the standard statewide rate is increased from 7.25% to 7.50%.
Single Sales Factor Apportionment Formula
Proposition 39 requires that taxpayers use a single sales factor apportionment formula to apportion income from multistate tax activities to California, beginning with the 2013 tax year. Currently, taxpayers may make an annual election to use the single sales factor apportionment formula rather than the standard double-weighted sales apportionment formula based on property, payroll, and sales factors. Apportioning trades or businesses that derive more than 50% of their gross business receipts from one or more qualified business activities (agricultural, extractive, savings and loan, and banking or financial business activities) will continue to apportion their business income to California by multiplying such income by the equally-weighted three-factor formula.
Taxpayers will be required to use the market-based sourcing rules for purposes of sourcing sales of other than tangible personal property. Special sourcing rules are also adopted for cable companies that are part of a qualified combined reporting group that makes an investment of at least $250 million in qualified expenditures in California.
Propositions 30 and 39, as approved by California voters at the November 6, 2012 general election; Revised 2012 Personal Income Tax Rate Schedules, California Franchise Tax Board, November 7, 2012
FTB Files Petition for Review of Gillette Decision
The Franchise Tax Board (FTB) has filed a petition with the California Supreme Court to review the Court of Appeal’s decision in Gillette v. FTB, in which the appellate court held that taxpayers had a right to elect to use the Multistate Tax Compact’s equally-weighted apportionment formula for purposes of apportioning their net income to determine their California corporation franchise and income tax liability. The appellate court held that California’s partial repeal of the Compact was unconstitutional because it violated the prohibition against impairing the obligation of contracts and the California Constitution’s reenactment rule.
The FTB contends the Supreme Court should grant review because the issues involved in the case affect tens of thousands of businesses doing business in and outside California as well as in the other Compact member states. The FTB also claims that the state would be liable for over $750 million in refunds if the taxpayers’ position is upheld, which would place a tremendous burden on the state after it relied on the state’s law for over 13 years, as well as providing an unexpected "windfall" to taxpayers who had previously filed under the double-weighted sales factor apportionment formula. The FTB also contends that the appellate court failed to perform the requisite "impairment of contracts" analysis prior to finding that the law repealing the Compact election was unconstitutional and that the court’s finding that the use of the "notwithstanding" language as a means to repeal the election violated the reenactment rule calls into question the validity of hundreds of California statutes.
The FTB makes the following arguments in support of its petition for review:
- While labeling the Compact as a contract between states, the appellate court failed to apply contractual law and analysis in interpreting the Compact. Under such an analysis, ascertaining the signatory states’ "intent and understanding" of the Compact and its obligations at the time the Compact was signed was essential. At the time California signed the Compact, Florida, which was a member of the Compact, had already adopted a statute that unilaterally repealed the Compact’s election and apportionment provisions. The Multistate Tax Commission, which was comprised of all the Compact signatory states, had adopted a unanimous resolution affirming Florida’s actions and confirming Florida’s good standing as a member of the Compact and the Commission. Thus it was the understanding of California and the other Compact members that states could partially repeal portions of the Compact without withdrawing from the whole Compact. This was further exemplified by the fact that numerous other members of the Compact have enacted similar provisions to California. The appellate court’s interpretation would allow nonparties to the Compact to assert an interpretation of the Compact that the members of the Compact had rejected.
- The Legislature clearly meant to repeal the election and to mandate the use of the double-weighted sales factor apportionment formula. Mandating that the Legislature use the words “Repealing §38006” rather than “Nothwithstanding §38006” is elevating form over substance in statutory interpretation and is contrary to established precedent that an existing statute can be repealed by subsequent legislation that applies "notwithstanding" the earlier legislation.
- Other provisions of the Compact have also been subsequently revised by California’s statutes, thereby augmenting considerably the state’s potential $750 million liability if the taxpayers’ position is upheld.
- The Supreme Court’s guidance in interpreting Compact law is important to provide certainty and uniformity in the interpretation of the many Compacts in which California is a member.
- Taxpayers were not members of the Compact and therefore did not have a contractual right under the Compact. By adopting the Compact, California conferred a statutory right, rather than a contractual right, to taxpayers to elect the Compact apportionment formula, which the Legislature had the sovereign right to subsequently amend.
- Under long-standing California law, the reenactment rule does not apply where one statute repeals or amends another statute by implication. The appellate court’s finding that neither the Legislature nor taxpayers were put on notice that the adoption of Rev. & Tax. Code §25128 and the use of the "notwithstanding §38006" language would repeal the equally-weighted apportionment formula election was not supported by the legislative history and record.
Gillette Co. v. Franchise Tax Board, California Supreme Court, No. S206587, petition for review filed November 13, 2012
Nexus of Partners Discussed
A partner in a partnership doing business in Illinois generally has sufficient nexus to be subject to Illinois income taxation with respect to his or her share of the partnership’s Illinois business income. The Illinois Department of Revenue stated in a general information letter that the guaranteed payment the taxpayer received from an LLP to be ordinary income of the partnership, which was characterized by the partnership as business income. Accordingly, the amount of the taxpayer’s guaranteed payment that was apportioned to Illinois by the partnership was taxable and also subject to withholding.
The DOR did note that although the matter has never been raised before an Illinois court, courts in other states have held that guaranteed payments received by a nonresident partner from a partnership doing business in the state are subject to the state’s income tax, even when the partner has no other connection with the state.
General Information Letter IT 12-0028-GIL, Illinois Department of Revenue, September 27, 2012
Apportionment of Sale of Stock of Subsidiary Company Addressed
Receipts from sale of stock in a subsidiary corporation are not included in the Illinois numerator of the sales factor when no income-producing activities are performed within Illinois. The Department of Revenue noted that Illinois regulations provide that "when gross receipts arise from the incidental or occasional sale of assets used in the regular course of a person’s trade or business, such gross receipts shall be excluded from the sales factor."
In this instance the taxpayer is in the business of investing in other entities, in the instant case Company A, and is not regularly in the business of buying and selling entities. The taxpayer had a gain from the sale of Company A. There is no unitary relationship between the taxpayer and Company A because Company A operates almost exclusively outside of the United States. Because the companies are not a unitary business group, pass-through income of Company A is apportioned at the pass-through entity level and is excluded from the income of the owner, the taxpayer.
Therefore, this sale of an investment entity by the taxpayer was deemed an "incidental or occasional sale" pursuant to the regulations, and the gross receipts recognized from the sale must be excluded from the sales factor of the taxpayer.
Private Letter Ruling, IT 12-0001-PLR, Illinois Department of Revenue, October 25, 2012
Dissolution of Corporation Discussed
The Illinois Department of Revenue has issued a corporate income tax general information letter stating that transferees of a dissolved corporation are potentially liable for unpaid Illinois income tax obligations of the corporation. The dissolution of a corporation under state law does not render uncollectible the corporation’s previously assessed income tax liabilities.
General Information Letter IT 12-0030-GIL, Illinois Department of Revenue, October 18, 2012
Purchases Taxable and Nontaxable Under Transportation Exemption
The Indiana Tax Court has held that certain purchases of tangible personal property by a licensed common carrier were not entitled to the transportation exemption from sales tax. Other property, however, did qualify for the exemption.
The court found that the carrier’s transportation services are generally provided as a continuous, integrated process of transporting its customers’ oversized equipment on the highways. The carrier’s services were not a series of separate services.
To qualify for the exemption, property must be necessary and integral to the provision of public transportation services. Property used in preparing customer estimates was not necessary and integral because it was not a part of the carrier’s public transportation process. Property used to plan the routes and obtain the travel permits was necessary and integral as the carrier could not legally haul oversized machinery without travel permits for its route. Property used to disassemble, load and secure customers’ machinery for subsequent movement over highways also was necessary and integral because, without disassembly, the machinery would be too heavy for loading and too large for legal road transport. Property used to transport, escort and secure its customers’ machinery was necessary and integral because it was the movement of another’s property for consideration. Property used in reassembly services at the customer’s location was not necessary and integral as the services were not public transportation services.
In addition, all property used to provide warehouse storage services was necessary and integral because temporary storage is considered to be an integral part of rendering public transportation. Property used to transport customers’ machinery to other locations for repair services was necessary and integral because a common carrier’s movement of another’s property over the highways for consideration is public transportation.
To qualify for the exemption, an item must be predominantly used in public transportation. The items that were necessary and integral to the carrier’s provision of public transportation services qualified for the exemption because roughly 70% of the jobs the carrier performed involved the provision of public transportation.
Wendt, LLP v. Indiana Department of Revenue, Indiana Tax Court, No. 02T10-0701-TA-2, October 30, 2012
Different Accounting Methods Allowed for Final SBT Return, Initial MBT Return
The Michigan Court of Appeals allowed a fiscal-year taxpayer to file its final single business tax return using the "actual method" and its initial Michigan business tax return using the "annual method." The Department of Treasury did not approve of the taxpayer using two different methods. The department argued that the lower court incorrectly interpreted the applicable statute (M.C.L. 208.1503). The appellate court disagreed: the statute gave taxpayers a choice to use the actual method or the annual method. Furthermore, the statute did not require taxpayers to use the same method for the final short year SBT return. Even though Revenue Administrative Bulletin 2007-5 directed taxpayers to use the same accounting method for both the final SBT return and the initial MBT return, it was not adopted under the Administrative Procedures Act and thus was merely explanatory. The department next argued that because the statute did not require consistency in methods of filing the final SBT return and the initial MBT return, the statute violated the state constitution’s uniformity guarantee. Again, the appellate court disagreed. The statute met a rational basis of review: the purpose behind providing alternative methods of tax computation was to create ease of administration. Accordingly, use of the different accounting methods was permitted for the final SBT return and the initial MBT return.
P&M Holding Group, LLP v. Department of Treasury, Michigan Court of Appeals, No. 307037, November 15, 2012
Nonresident’s Stock Option Income Partially Allocable to New York
In a New York personal income tax case involving a nonresident individual who, in 2006, exercised stock options received from his airline employer, it was proper for the Division of Taxation to allocate a portion of the stock option income to New York. Given the individual’s work history in the state, the division reasonably and correctly concluded that he worked in New York during the allocation period. The division thus rationally concluded that the 2006 stock option income was allocable to New York in accordance with Reg. §132.24. Further, the method of allocation reflected in the deficiency notice (i.e., the individual’s workday allocation for his last full year of employment at the airline) was reasonable under the circumstances. At that point, the individual had not provided any option dates of grant, vesting, or exercise to enable the division to source the option income under any of the methods provided for in the regulations.
The sourcing method reflected in the revised deficiency was also reasonable. Although the division asserted that it was an alternative method under the regulations, the method was actually an approximation of the date-of-grant to date-of-termination method provided for in the regulations. The division’s use of a year-of-grant starting point for the allocation period (rather than date-of-grant) was reasonable because the individual did not provide any information regarding specific New York or non-New York workdays during the allocation period. With respect to the options granted in 1996 through 2001, the division’s inclusion of New York workdays only through 2001 in the numerator of the workday fraction, while using total workdays through April 30, 2005 (date of retirement), was an apparent error in the individual’s favor.
The individual contended that the regulation was unfair and unworkable for nonresidents. However, under the regulation, income from stock options is subject to New York income tax only when a nonresident works in New York during the allocation period. In addition, such income is apportioned to New York based on the ratio of New York workdays to total workdays during the allocation period. Because the regulation subjects to New York income tax only that portion of option compensation attributable to New York employment, it is neither unfair nor unworkable.
The individual also argued that the provisions in question were improperly applied retroactively, but that argument was rejected.
The portion of the deficiency related to deferred compensation was also sustained, although the division was directed to make an adjustment to the computation. The individual offered no evidence to show that the income constituted a nontaxable annuity and introduced no evidence to show that the allocation method employed by the division with respect to the income was improper.
Gleason, New York Division of Tax Appeals, Administrative Law Judge Unit, DTA No. 823829, October 25, 2012
Comptroller Rejects Use of MTC’s Three-Factor Apportionment Formula Again
A taxpayer’s amended Texas franchise tax reports and claimed refunds for tax years 2008, 2009, and 2010 were properly denied because the taxpayer used the three-factor apportionment method permitted under the Multistate Tax Compact (MTC) rather than the single-factor apportionment method.
The Comptroller ruled that the Texas Franchise Tax Act clearly requires use of the single-factor apportionment method and does not allow usage of the MTC formula. In rejecting the amended reports, the Comptroller noted that it has decided this exact issue multiple times and that the taxpayer did not raise any arguments that would compel a reconsideration of the previous holdings that entities may not elect to use the MTC’s three-factor apportionment formula.
Decision, Hearing No. 106,149, Texas Comptroller of Public Accounts, September 11, 2012
If you have any questions, please contact your tax advisor.
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