Current corporate income tax developments.

In late 1995 and throughout 1996, an overwhelming number of state (1) statutes were modified, added and deleted, (2) court cases were decided, (3) regulations were proposed, issued and modified and (4) notices, bulletins and rulings were issued or withdrawn. It is impractical even to attempt to identify most of the activity that occurred in the multi-state corporate income and franchise tax area during that period. Accordingly, this article focuses on significant activities in two areas that affect the majority of taxpayers -- nexus and apportionment formulas -- and highlights legislation, court decisions, regulations and rulings that affect many corporate taxpayers.

Nexus

The state in which an entity is incorporated has jurisdiction to tax the corporation, regardless of the amount of business activity conducted there. Whether a state can tax the income of a corporation incorporated outside its borders depends on the relationship between the corporation and the state in which it is conducting business. When a corporation's income is derived partly from property owned or business conducted in more than one state, the corporation will be subject to tax in a state if sufficient nexus is established with that state. ("Nexus" is the degree of business activity that must be present before a taxing jurisdiction can tax an out-of-state corporation.) As indicated below, identifying whether a taxpayer has established nexus remains an area of controversy.

Licensing Intangibles

No state tax case in recent years has cultivated more controversy than Geoffrey, Inc. v. South Carolina Tax Comm'n,[1] in which the South Carolina Supreme Court held that a Delaware passive investment company whose sole connection with South Carolina was the licensing of a trademark used there by a related corporation, was subject to South Carolina income tax. The court held that the physical presence requirements set forth in National Bellas Hess, Inc. v. Dep't of Rev. of Ill.[2] and Quill Corp. v. North Dakota[3] did not apply because Geoffrey was not a sales tax case. According to the court, licensing of intangibles for use in South Carolina and deriving income from their use met the Commerce Clause's substantial nexus test.

While state officials were delighted when the U.S. Supreme Court denied certiorari in Geoffrey, only a few states took immediate action; however, the number of states implementing Geoffrey-type regulations or rules (e.g., Arkansas,[4]( Florida[5], Massachusetts[6], New Jersey,[7] North Carolina[8] and Wisconsin[9]) has dramatically increased. In addition, a couple of states have proposed the adoption of regulations providing that the in-state licensing of trademarks or trade names creates nexus. Over the past year, in auditing corporations, several states actively asserted the Geoffrey nexus approach; these actions are highlighted below.

* Alabama

While some states have attempted to broaden their nexus standards based on Geoffrey, others have abandoned their efforts to pursue that approach. Alabama issued "emergency regulations"[10] effective for tax years beginning after 1994 (and effective only until Feb. 13, 1996) attempting to impose a Geoffrey-type nexus standard for both corporate income and franchise tax purposes. These regulations were withdrawn for further examination; it is unlikely that the state win reintroduce them, based on the decision in Cerro Copper Products, Inc. v. State of Alabama,(11) which held that there is no nexus without physical presence in the state.

* Arkansas

The Arkansas Department of Finance and Administration (DFA) issued Revenue Policy Statement 1995-2,[12] which provides that royalties received from the management of intangible property constitutes business income under Arkansas law and is thus subject to the state's income tax. In developing its policy position, the DFA interpreted the Supreme Court's refusal to hear Geoffrey as an affirmation that the holding is to be applied by all states.

* Iowa

Rule 701-54.2(422) imposes a corporate income tax based on the use of intangibles in the state. An intangible has an Iowa situs if it becomes an integral part of a business activity occurring in the state. Income from intangible property in the state constitutes income from Iowa sources and subjects the holder to state income tax.

* Massachusetts

Massachusetts Department of Revenue (DOR) Directive 96-2[13] imposes excise (income tax on corporations licensing intangibles in the state. Directive 96-2 codified the DOR's informal policy of asserting nexus when a corporation uses intangible property to generate gross receipts in Massachusetts. Effective for tax years beginning after 1995, the Directive states that a corporations activity must be "purposeful" and not de minimis for nexus to be asserted, and provides that companies licensing canned computer software are not subject to the corporate tax, the DOR's position is that such licenses are actually sales of tangible personal properly.

* Mississippi

In 1996, in an attempt to expand the definition of "doing business" in the state, the legislature introduced HB 756, under which foreign corporations having or deriving income in Mississippi would be subject to state income tax. However, the state legislature faded to timely act on the bill, it died in committee.

* New Jersey

The New Jersey Division of Taxation (DOT) adopted regulations aimed at taxing corporations with no physical presence in the state. NJ. Reg. 18:7-1.9 provides that out-of-state corporations receiving fees from New Jersey companies for licensing trademarks for use there are subject to New Jersey's corporate business tax. Taxpayers have already begun testing the validity of the new regulation. Re/Max International Inc. filed suit in New Jersey Tax Court protesting the DOT's final determination that it owes New Jersey tax; the company has no physical presence in the state and is not licensed to do business there, but licenses its trademark to unrelated corporations doing business in New Jersey.

* North Carolina

The North Carolina DOR proposed regulations attempting to impose income tax on out-of-state financial institutions having income from intangibles in the state, these regulations were rejected by the North Carolina Rules Review Commission (NCRRC).[14]

* Tennessee

Over the past year and a half, the Tennessee DOR has taken the Geoffrey approach in audits and assessed tax, interest and penalties against numerous taxpayers who license trademarks and trade names in the state. In response, several taxpayers have filed law suits that are expected to be heard in late 1997.

Limited Partners and LLC Members

* Alabama

In Rev. Rul. 96-005,[15] the Alabama DOR ruled that a corporate member not doing business in the state) of a limited liability company (LLC) doing business in the state is not subject to the corporation franchise tax, mere ownership of an investment in Alabama does not constitute doing business in the state. The ruling did not address the income taxation of an LLC corporate member operating in Alabama.

* Tennessee

In 1996, the state issued additional rulings holding that an out-of-state corporate partner, whose only connection with the state is the ownership of a limited partner interest in a partnership doing business there, is not subject to Tennessee corporate franchise md excise taxes.[16]

In-State Deliveries in Company-Owned Vehicles

* Massachusetts and Virginia

Courts in Massachusetts[17] and Virginia[18] have ruled in favor of the taxpayer that the protection afforded by P.L. 86-272 extends to companies whose activities in the taxing state are limited to the solicitation of sales of tangible personal property, but deliver their products to customers in the taxing state using their own company trucks. It is not presently clear whether these states will appeal.

Use of In-State Printers

Over the past several years, a number of states have enacted laws exempting some out-of-state customers of in-state printers from certain taxes. In 1996, Connecticut enacted such an exemption; New York and West Virginia issued rulings clarifying that out-of-state customers of in-state printing services are not to be subject to state tax if their in-state activities are limited.

* Connecticut

G.S. Section 12-407 (15), enacted by Act 104 and effective for tax years starting after 1995, excludes from the definition of "doing business" the following activities of an out-of-state company that contracts with an in-state commercial printer for printing and distribution of material: (1) the ownership or leasing of tangible or intangible property located on the in-state commercial printers premises; (2) the sale of any kind of property produced or processed at and shipped or distributed from the in-state printers premises: (3) the quality control, distribution or printing-related activities of the out-of-state company's employees or agents at the in-state printers premises and (4) the activities performed by the in-state printer for or on behalf of the out-of-state company.

* New York

The New York State Department of Taxation and Finance recently ruled[19] that out-of-state customers of printing and mailing list services and promotional materials business are not subject to sales, use or corporate franchise taxes if their contacts with the state are limited. The ruling addresses out-of-state businesses that purchase (1) promotional materials or (2) printing or mailing services related to such materials. If the seller delivers the materials to the buyer's out-of-state customers or to a New York mailer who delivers them outside the state, the following activities in New York will not create sufficient nexus for the out-of-state customer: (1) the holding of promotional materials and the holding or use of utilized property (e.g., mechanicals, negatives, separations, transparencies, computer discs or tape, raw paper, computerized mailing lists, software and digitalized pictures or other information) by the seller or mailer for a reasonable period and (2) the sending of an employee into New York for quality control purposes.

* West Virginia

In Technical Assistance Advisory 96-003[20] the West Virginia State Tax Department (STD) held that a commercial printer's out-of-state customers' contacts with the state do not constitute sufficient nexus to subject them to sales, use, income or business franchise tax. The printer was an out-of-state corporation with a plant in the state. The STD found that it is clear that all contacts that the out-of-state customers have with West Virginia are directly connected with, limited to and in furtherance of services the printer contractually agrees to provide to them as customers, it concluded that the customers' mere ownership of raw materials, paper inventory, work-in-progress and finished goods and occasional visits to the printer's facility for the limited purpose of performing ancillary activities in connection with their print jobs are not sufficient contacts to create substantial nexus under the Commerce Clause.

Economic Nexus for Financial Institutions

A few states (e.g., Indiana, Massachusetts, Minnesota, Tennessee and West Virginia) have extended their taxing jurisdiction to include financial institutions that have no physical presence (i.e., employees or offices) in the state. Under these states' economic nexus statutes, nexus for financial institutions is established if the institution has a certain number of customers or level of capital in the state or derives a certain level of income sourced to the state. Although the constitutionality of such provisions is questionable (because certain interstate banking transactions can be done with little or no physical contact with a state), several states have modified their nexus standards for financial institutions. In 1996, Kentucky and North Carolina adopted or proposed economic nexus standards for financial institutions.

* Kentucky

The Kentucky General Assembly repealed the bank shares property tax and enacted bank franchise and local deposits franchise taxes. Under HB 416, certain out-of-state financial institutions are engaged in business in Kentucky if they (1) solicit and/or obtain the business of 20 or more customers or (2) have at least $100,000 of receipts attributable to Kentucky. These provisions are effective for calendar year 1996; the first returns and payments are due Mar. 15, 1997.

* North Carolina

The North Carolina DOR proposed amendments to the state's doing business regulations. Under the proposed amendments, the definition of "doing business" for North Carolina corporate income tax purposes would have been expanded to include (1) conducting any activity resulting in the acquisition or control of property tangible or intangible), including (but not limited to) receivables generated by and/for from credit card transactions and loans secured or unsecured) if the payor is located in the state and (2) the conducting of any activity resulting in the origination or acquisition of a loan when real property in the state serves as collateral for the receivable without regard to the location of the borrower. The DOR's proposed amendments were met with substantial opposition by taxpayers and practitioners.

In November 1996, the NCRRC rejected the DOR's proposed amendments, because the rules did not clearly define "doing business" and were inconsistent with the description offered by the DOR.[21]

* Tennessee

Tennessee adopted economic nexus provisions for financial institutions, effective for corporate fiscal years ending after July 14, 1990. Over the years, the DOR has been fairly aggressive in pursuing out-of-state financial institutions under the economic nexus provisions. In the past year, two cases have been filed in the Tennessee Chancery Court asserting that the state's economic nexus provisions for financial institutions are unconstitutional; the first of these is expected to be heard by this summer.

Miscellaneous Nexus Issues

* MTC Nexus Bulletin 95-1

The Multistate Tax Commission (MTC) released National Nexus Program Bulletin 95-1 in December 1995, which stated that nexus is established for sales and use, income and franchise tax purposes if in-state repairs of computers are provided to computer manufacturers and marketers by third-party in-state repair service providers. Opposition to Bulletin 95-1 was universal, several parties objected in part to the questionable reasoning on which the MTC based its conclusions. In particular, California withdrew its support for Bulletin 95-1 almost immediately, due in part to the potentially negative impact on the state's tax revenues, further, the state legislature made future funding of the MTC contingent on it instituting an open-meeting policy. Bulletin 95-1 also angered the Motion Picture Association of America and the Software Industry Coalition to the point that they almost persuaded the state to withdraw from the MTC.[22]

* California further defines solicitation under P.L. 86-272

In Brown Group Retail, Inc. v. Franchise Tax Board,[23] the California Court of Appeal ruled that the activities of an out-of-state shoe manufacturer's and distributors independent retail distributors (IRDs) violated the protections afforded under P.L. 86-272, subjecting the taxpayer to franchise tax. Brown Group limited its activities in California to employing sales representatives, using IRDs and leasing cars for all of these workers. The IRDs did not solicit sales, but acted as business advisers to the retailers, assisting with merchandising, advertising layouts, site selection, lease negotiations, store design, office personnel training and sales seminars. The Court of Appeal ruled that these business advisory services were not request-related activities that invited sales. Since the IRDs, activities were not protected solicitation under P.L. 86-272, Brown Group could not claim immunity thereunder.

* Internet advertising does not create nexus

A New York district court ruled in Bensusan Restaurant Corp. v King[24] that placing an advertisement on an Internet site located on a Missouri computer server does not establish nexus with New York. The case involved a New York corporation that sued a Missouri individual for trademark infringement; the district court dismissed the action on a finding that it lacked personal jurisdiction over the defendant. In so deciding, the court applied the tax nexus standard for determining whether a party is subject to personal jurisdiction in a state civil court proceeding.

* Officers' presence in Florida creates nexus

The Florida DOR ruled[25] that an out-of-state corporation that owned no property and had no offices in Florida had sufficient nexus for income tax purposes. Under Fla. Admin. Code Ann. Rule 12C-1.011(1)(n), a taxpayer is conducting business in the state if corporate management occurs there. Because eight of the taxpayer's 15 key officers lived in Florida, the DOR concluded that management occurred in Florida.

* Iowa clarifies nexus

For tax years beginning after 1995, Iowa Code Section 422.34A provides that a foreign corporation is not subject to Iowa corporate income tax if its activities in the state are limited to (1) holding board of directors, or shareholders, meetings' (2) holding holiday parties or employee appreciation dinners, (3) maintaining bank accounts, (4) borrowing money (with or without security), (5) using the courts, (6) owning or controlling a subsidiary incorporated in or transacting business in Iowa (if the holding company or parent has no physical presence in Iowa relating to the subsidiary) and in recruiting personnel (if the actual hiring occurs outside the state).

Apportionment Formulas

A multistate corporations business income is apportioned among the states in which it does business using an apportionment percentage for each state having jurisdiction to tax the corporation. To determine the apportionment percentage, a ratio is established for each of the factors included in the state's formula; each ratio is calculated by comparing the corporation's level of a specific business activity in the state to the total corporate activity of that type everywhere. The ratios are then summed, weighted (if required) and averaged to determine the corporation's apportionment percentage for the state; the apportionment percentage is then multiplied by total corporate business income to determine the income subject to tax by the state.

Although apportionment formulas vary among jurisdictions, most states use a three-factor formula that includes sales, payroll and property factors. Although many states equally weight the three factors, more than 50% of the states weight the sales factor more heavily than the others, most of these double-weight the sales factor.

Use of a double-weighted sales factor tends to pull a larger percentage of an out-of-state corporation's income into the state's taxing jurisdiction, but generally provides tax relief for instate corporations; the latter usually own significantly more property and incur more payroll costs (lesser-weighted factors) in the state than do out-of-state corporations. Accordingly, a change in the weighting of factors or in the apportionment formula itself can shift the tax burden to out-of-state businesses and provide tax relief for in-state businesses.

Example: X Corporation, located in State A, realized $1,500,000 of taxable income from sales of its products in States A and B. X's gross sales, payroll and property are allocated between those states as follows:

                    State A     State B        Total
Sales             $2,000,000   $2,000,000   $4,000,000
Payroll            1,500,000            0    1,500,000
Property           2,500,000            0    2,500,000
Income tax rate          10%           5%

If A uses a normally weighted sales factor in its three-factor apportionment formula, $1,249,500 of X's taxable income is apportioned to A.

Sales ($2,000,000/$4,000,000)                50%
Payroll ($1,500,000/$1,500,000)             100%
Property ($2,500,000/$2,500,000)            100%
Sum of factors                              250%
Average                            /          3
State A apportionment                      83.3%
Taxable income                     x $1,500,000
State A taxable income                1,249,500
Tax rate                           x         10%
Tax due to State A                     $124,950

However, if A uses a double-weighted sales factor in its apportionment formula, $1,125,000 of X's taxable income is apportioned to A resulting in a 10% ($12,450) reduction in its A tax liability.

Sales                               50%
Sales                               50%
Payroll                            100%
Property                           100%
Sum of factors                     300%
Average                         /    4
State A apportionment             75.0%
Taxable income             x 1,500,000
State A taxable income       1,125,000
Tax rate                   x        10%
Tax due to State A            $112,500

While X realizes tax savings if A changes its apportionment formula, the opposite occurs if B changes its apportionment formula. If B uses an evenly weighted three-factor formula, X will incur $12,500 (0.166 x $1,500,000 x 0.05) of tax. If B uses a double-weighted sales factor, X will incur $18,750 (0.25 x $1,500,000 x 0.05) of tax, a 50% increase. If B uses a single-sales-factor formula, X will incur $37,500 (0.50 x $1,500,000 x 0.05) of tax, a 200% increase.

Over the past several years, legislative changes to the apportionment formula have become common; as was noted, more than 50% of the states accord more weight to the sales factor than to the payroll or property factor. Changes in the apportionment formula may also be used to provide special relief or tax benefits to specific industries or to properly reflect the operations of a special industry. Apportionment formula changes that became effective or were enacted during the past year are summarized below.

* California

For income years beginning after 1995, California has adopted apportionment provisions for banks and financial corporations. While corporate taxpayers outside of agricultural and extractive businesses generally are required to apportion their income under a three-factor formula found in Reg. 25128 that includes a double-weighted sales factor, new Reg. 25137-4.2 includes an evenly weighted three-factor formula, which is the formula included in the MTC model regulation.

* Connecticut

For tax years beginning in 1996, corporations that provide management, distribution or administrative services to regulated investment companies and corporations that render securities brokerage services may elect to use a single-factor apportionment formula (receipts) in computing their state corporate income tax. Under G. S. Section 12-218(f), the sales factor is computed using a market-sourcing approach. Once the election is made, it must be used for five succeeding years.

* Georgia

For tax years beginning after 1995, under Ga. Code Section 48-7-31 (d)(3), corporations that derive income from holding and/or licensing intangibles must use a double-weighted sales factor in calculating their Georgia apportionment factor. This conforms the rules for licensing intangibles with the rules for manufacturing entities.

* Louisiana

Effective for tax years beginning after 1996, a corporation whose net apportionable income is derived primarily from manufacturing or merchandising will double-weight the sales factor of the three-factor apportionment formula in computing its income apportioned to Louisiana, under La. Rev. Stats. Section 47:245F(2).

* Massachusetts

Under G.L. Section 38(c) and k, for tax years 1996-1999, a defense contractor with at least 90% of its property and payroll in Massachusetts can use a single-sales-factor apportionment formula. For other manufacturers, the single-sales-factor formula is phased in over five years, beginning with the 1996 tax year. Accordingly, for tax years beginning after 1999, both domestic and foreign manufacturing corporations will apportion their income to Massachusetts using a single-sales-factor apportionment formula.

* Massachusetts

G.L. Section 38(f)2 provides significant tax breaks for mutual fund companies. For tax years after 1996, a qualified mutual fund corporation's income derived from sales will be sourced based on the ratio of shares of the mutual fund held by shareholders in the state to the shares held by shareholders everywhere. Moreover, there is no throwback of sales to Massachusetts, even if the mutual fund is not taxable in the jurisdiction to which certain sales are sourced. Under prior law, sourcing was based on the location of the fund's costs of performance. In addition, effective July 1, 1997, a qualified mutual fund corporation will apportion its income to Massachusetts by using single-sales-factor apportionment, as long as it satisfies the jobs growth requirement set forth in G.L. Section 38(m).

Michigan

For tax years beginning before 1997, the single business tax (SBT) for most corporations was apportioned using a three-factor formula that included a double-weighted sales factor. Under MCL Section 208.45(5), for the 1997 and 1998 tax years, the SBT apportionment formula for most corporations is 10% property, 10% payroll and 80% sales. However, for the 1998 tax year, MCL Section 208.45(7) provides that if the amended capital acquisition deduction (CAD) under MCL Section 208.23(e) is not in effect, the apportionment formula will instead be 20% property, 20% payroll and 60% sales.

For tax years beginning after 1998, the SBT apportionment formula will be 5% property, 5% payroll and 90% sales, however, if the amended CAD is not in effect, MCL Section 208.45(6) provides that the SBT apportionment formula will instead be 15% property, 15% payroll and 70% sales.

* New Jersey

For fiscal or calendar accounting years beginning after June 30, 1996, the apportionment formula for most corporations includes a double-weighted sales factor, under N.J.S.A. Section 54:10A-6.

* New York City

Effective for tax years beginning after June 30, 1996, NYC Admin. Code Section 11-604)(3)(a)(8) provides that manufacturing corporations can elect to double-weight their receipts factor in computing the business allocation percentage under the general corporation tax or the unincorporated business tax.

* Tennessee

While the state uses standard three-factor apportionment, for tax years beginning after Dec. 14, 1997, Tenn. Code Ann. Section 67-4-910 provides that the numerator of the excise/franchise apportionment formula includes a payroll factor, a property factor and 1 1/2 times the sales factor, the denominator is 3.5. For tax years beginning after Dec. 14, 1998, the numerator includes a double-weighted sales factor; the denominator is 4.

Other State Activities

Responses to Fulton

In Fulton Corp. v. Faulkner,[26] the US. Supreme Court struck down North Carolina's intangibles tax as violative of the Commerce Clause, because it granted an exemption to holders of corporate stock based on the corporation's level of activity in the state. Thus, holders of stock in corporations that did little or no business in North Carolina were subject to higher taxes than holders of stock in corporations that conducted most of their business in North Carolina. Such an exemption provided an economic disincentive for investment in out-of-state companies, thus discriminating against interstate commerce.

The Court's decision has created refund potential in a number of states and leads to the possibility of repeal of similar intangibles tax structures in other states. The states, responses to Fulton and potential refund opportunities are highlighted below.

* Alabama

In anticipation of litigation based on Fulton, the legislature amended Ala. Code Section, 40-14-79 to allow taxpayers, for domestic corporation shares tax purposes, to deduct from the shares tax base the value of shares held in foreign subsidiaries. Prior law allowed taxpayers to deduct the value of investments in domestic subsidiaries (but not in foreign subsidiaries) doing business in Alabama. The amended provision is retroactively effective to Sept. 30, 1994; retroactive refunds are not available.

* Georgia

In light of Fulton and a law suit filed in Dekalb Superior Court by the Southeastern Legal Foundation, the Georgia General Assembly passed a series of bills and resolutions eliminating the state's intangibles tax.[27]

* Kentucky

The Kentucky Supreme Court reversed its decision in Herschel St. Ledger v. Rev. Cabinet[28] after the US. Supreme Court vacated that decision. Originally, the Kentucky Supreme Court held that the states intangibles tax, levied on bank deposits, was unconstitutional because different rates applied to deposits of in-state and out-of-state banks. However, the corporate shares tax, which imposed lower rates for shares of corporations paying taxes to the state on at least 75% of their total property, was valid, because it is more burdensome to collect the tax from out-of-state shareholders. The U.S. Supreme Court ordered the Kentucky court to reconsider its decision in St. Ledger in light of Fulton; the Kentucky Supreme Court subsequently reversed its holding that the corporate shares tax was constitutional. Refund applications must be filed, under KRS 134.590(1)-(2), within two years of payment of the tax.

* North Carolina

Since Fulton, several other North Carolina tax provisions have come under scrutiny for similar constitutional problems, one such provision is the preferential treatment for, domestic corporations under the dividend exclusion statutes. N.C. Gen. Stats. Section 105.130.7 (4) allows in-state-domiciled corporations to deduct dividends received from subsidiaries in computing state taxable income, without adding expenses related to such dividends; this treatment is not available to corporations filing in North Carolina but domiciled outside the state. Accordingly, the taxing scheme may be unconstitutional and refunds potentially may be available.

* Pennsylvania

Taxpayers in Pennsylvania have questioned the constitutionality of the state's personal property tax, which is imposed on stock and other intangibles held by county residents; an exemption is provided for stock held in corporations subject to the capital stock/franchise tax. Accordingly, the Pennsylvania tax appears to be even more facially discriminatory than the North Carolina tax involved in Fulton. Suits have been filed in several Pennsylvania counties challenging the tax on constitutional grounds. If the tax is held to be unconstitutional, taxpayers may be entitled to receive refunds for personal property taxes paid in prior years.

Federal S Corporation Changes

The Small Business Job Protection Act of 1996 (SBJPA) made several changes to the Internal Revenue Code's (IRC's) corporation provisions.[29] Depending on how a state's income tax law interacts with the IRC and how state law defines an S corporation, the SBJPA changes may not be applicable in certain states until the states' statutes are legislatively modified.

* California

California adopted the version of the S rules contained in the IRC in effect on Jan. 1, 1993; because it has not yet conformed to the S corporation amendments made by the SBJPA, corporations that elect S status under the SBJPA provisions (e.g., more than 35 shareholders) will not be S corporations for California tax purposes and will be treated as C corporations.[30] A bill to conform to the SBJPA S corporation provisions has been introduced in California; passage is currently uncertain. Further, until appropriate changes are made to California law, the check-the-box regulations also do not apply for California tax purposes.

* Pennsylvania

Pa. Code Section 9.13 defines an S corporation as one that (1) has a valid S election in effect under the 1983 version of the IRC and (2) does not have passive investment income in excess of 25% of its gross receipts. Therefore, if a corporation with a current Pennsylvania S election violates the 1983 IRC provisions, its Pennsylvania S election is terminated and cannot be reelected for five years. This is the position maintained by the Pennsylvania DOR and has been incorporated into a recent Statement of Policy.[31]

The power to reflect the SBJPA changes rests with the Pennsylvania General Assembly, but no such legislation has been proposed. A representative from the Office of Chief Counsel has indicated that the DOR will not actively seek passage of such legislation.

Tax Base Issues

* Louisiana

In Dow Hydrocarbons & Resources, Inc.,[32] a Louisiana district court ruled unconstitutional a 1993 law Act 690) that reclassified dividend income from "allocable income" to "apportionable income" because it amounted to a new tax or an increase in an existing tax), which the state legislature could not enact in an odd-number year. Concluding that Act 690 was unconstitutional from its inception, the court ordered the state to refund to the taxpayer the corporate income tax paid under protest, plus interest and court costs.

Pending the resolution of continuing litigation in this case, taxpayers should consider filing their returns under protest, but in the manner required by Act 690. In addition, taxpayers should consider filing protective refunds claims to ensure that the statute of limitations does not run before a final decision in Dow is rendered.

* Maine

In E.I. du Pont de Nemours & Co. v. State Tax Ass'r,[33] the Maine Supreme judicial Court reversed a lower court and ruled that taxpayers must include dividends from foreign subsidiaries in income apportionable to Maine. The court concurred with the Kansas Supreme Courts reasoning in Appeal of Morton Thiokol[34] that the water's-edge combined reporting method results in equal taxation of both domestic and foreign subsidiaries. Under that method, the income of all domestic subsidiaries becomes subject to Maine's income tax due to their inclusion in a combined report. Because Maine imposes its tax on all domestic subsidiaries, it is permissible under both the US. and Maine Constitutions to impose an income tax on dividends received from a foreign subsidiary.

* Massachusetts

In 1995, the Massachusetts Supreme Judicial Court ruled in Perini Corp. v. Comm'r of Rev.[35] that the computation of the net worth portion of the corporate excise tax, as applied to investments in subsidiaries, was unconstitutional for all tax years. G.L. Section 30(8) and j allowed corporations to exclude from their taxable net worth base certain investments in 80% subsidiaries, but not if (1) the parent was incorporated in Massachusetts and the subsidiary was incorporated in another jurisdiction, or (2) the parent was not incorporated in Massachusetts and the subsidiary was incorporated or doing business in Massachusetts.

It was unclear whether taxpayers could rely on Perini to obtain a refund of taxes paid in prior years. In 1996, the Massachusetts DOR asked the Massachusetts Supreme judicial Court to rule that taxpayers who, based on Perini, timely filed refund claims for years ending prior to 1995 be permitted to obtain refunds, but that the exclusion be denied for investments in 80% subsidiaries for tax years ending after lB. However, the court agreed with the taxpayer, holding that the exclusion applies for all open tax years(36); the ruling provides an opportunity for taxpayers who have overpaid net worth taxes to file refund claims for all open tax years. (Generally, the statute of limitations is three years.)

* New Jersey

The law requiring that 90% of interest paid directly or indirectly to a taxpayers 10%-or-more shareholder be added back to Federal taxable income in computing the New Jersey corporate business (income) tax was repealed, effective for tax years ending after Jan. 10.

* New York City

NYC Admin. Code Section 11-604 phases in elimination of the add-back under the general corporation tax of officers, salaries and other compensation. For tax years beginning after June 30, 1996, 75% of the officers, compensation must be added back, a 50% add-back is required for tax years beginning after June 30, 1998. The add-back is completely eliminated for tax years beginning after June 30 1999.

Filing Methods

* Kentucky

Ending a long controversy over whether corporations conducting a unitary business could file a combined report, KRS 141.200(1)(a) allows an affiliated group to elect to file a consolidated state income tax return for tax years ending after Dec. 30, 1995. The Kentucky consolidated return must include all corporations that are members of the affiliated group (as defined by IRC Sec. 1504(a) and related regulations, except any corporation exempt from corporate income tax under KRS 141.040. Accordingly, the consolidated Kentucky return includes all members of the Federal affiliated group (even members that do not have sufficient nexus with Kentucky to file a separate return if the consolidated return election is not made. The consolidated return election may be made whether or not a Federal consolidated return is filed once made, the election is binding for eight years.

The legislation also states that for 1995 and thereafter, a combined reporting filing option is not available for unitary businesses, instead, the only filing options are separate or consolidated returns. However, for 1994 and prior tax years, based on the Kentucky Supreme Courts decision in GTE v. Rev. Cabinet,(38) corporations comprising a unitary business may file a Kentucky return using unitary reporting. Accordingly, corporations should analyze whether filing under this method for prior years would result in state tax refunds. (The statute of limitations for filing refund claims generally is four years from the date the return was filed.)

* Maine

In Great Northern Nekoosa Corp. v. State Tax Ass'r,(39) the Maine Supreme judicial Court ruled that the taxpayer could not exclude from the numerator of its sales factor sales made to states in which an affiliated corporation had nexus. According to the court, Maine's definition of taxpayer,, does not include members of the selling corporations affiliated group., accordingly, the taxpayer could not avoid the throwback rule because it could not create nexus for itself via an affiliates nexus in a state.

Tax Rate Reductions

* California

California enacted a number of important changes during its 1996 legislative session, the most important of which was the reduction of the corporate franchise (income) tax rate under Cal. Rev. k Tax Code Sections 23151 and 21544 from 9.3% to 8.84% for income tax years beginning after 1996.

* North Carolina

In addition to providing incentives to create high-quality jobs and business expansion, 1996 legislation phased in a reduction to the corporate income tax rate. For tax years beginning in 1997, the corporate income tax rate under G.S. Section 105-130.3 is 7.5%, 7% in 1998 and 1999 and 6.9% in 2000.

Other Taxes

* New York State repeals real property transfer

gains tax

The real property transfer gains tax was repealed effective for real property transfers occurring after June 14, 1996.(40)

* Virginia modifies business, professional

and occupational license tax

The business, professional and occupational license (BPOL) tax is a gross receipts tax imposed by local taxing jurisdictions (e.g., townships, cities and counties) in Virginia. During 1996, several changes were made to the BPOL tax to improve uniformity and administration. Changes and clarification were made under Va. Code Sections 58.1-3703.1 and 58.1-3708 and other sections with respect to tax thresholds and license fees; the situs of gross receipts; new exemption for venture capital funds and nonprofit organizations; a new exclusion for receipts attributable to business conducted in another state or foreign county in which the license is liable for an income tax or other tax based on income; and the adoption of uniform ordinate provisions and specified administrative appeals and rulings procedures. These changes are generally effective for license years beginning after 1996; however, certain provisions may, at a locality's election, be adopted and applied in an earlier license year.

Conclusion

The multistate corporate income and franchise tax area is growing exponentially, more companies than ever before are operating in that arena. In this age of providing incentives to retain or attract businesses, the states, corporate tax statutes are changing at an accelerated pace and becoming more complex. This article has attempted to provide only a summary of the significant state cases, regulations and rulings issued in the recent past, with a focus on nexus issues and apportionment formula changes.

(1) Geoffrey Inc. v. South Carolina Tax Comm'n, 437 SE 2d 13 (1993), cert. denied see State & Local Taxes, "States Enamored With Deceptively Attractive Geoffrey Nexus, Position," The Tax Adviser 376 (June 1996).

(2)National Bellas Hess, Inc. v. Dep't of Rev. of Ill., 386 US 753 (1967).

(3) Quill Corp. v. North Dakota, 504 US 298 (1992).

(4) Ark. Reg. 1996-3.

(5) Fla. Rule 12C-1.011(1)(p).

(6) Mass. Reg. 830 CMR 63.38.1(9)(d)

(7)See Letter, Audit Services Branch, NJ Div. of Tax'n (3/19/96).

(8) N.C. Reg. 17:05C.0102(a)(5)(C).

(9) See Wisc. Dep't of Rev., Adm. Rul., Tax Releases (1/1/95).

(10) Ala. Reg. 810-3-2-04ER.

(11) Cerro Copper Products, Inc. v. State if Alabama, Dep't if Rev,m Admin. L. Div., No. F.94-444 (12/11/95).

(12) Rev. Policy Stmt. 1995-2 (11/16/95).

(13) Dep't of Rev. Directive 96-2 (7/3/96).

(14) See the discussion below under "Economic Nexus for Financial Institutions."

(15) Alabama Rev. Rul. 96-005 (9/4/96).

(16) See Tenn. Rev. Rul. No. 96-15 (4/16/96).

(17) Nat'l Private Truck Council v. Comm'r of Rev., Mass Super. Ct., Civ. Actions No. 93-5647-H (1/3/97).

(18) Dep't of Tax'n v. Nat'l Private Truck Council, Va. Sup. Ct., No. 960575 (1/10/97).

(19) New York State Dep't of Tax'n and Fin. Op. of Counsel (10/3/96).

(20) Tech. Ass't Advisory 96-003 (6/19/96).

(21) See Cummings, "North Carolina Review Panel Rejects Proposed Nexus Rule," 96 State Tax Notes 230-44 (11/27/96).

(22) See Hamilton, "An Eye Stateside: The Untold National Tax Policy Story," 97 State Tax Notes 6-34 (1/9/97).

(23) Brown Group Retail, Inc. v. California Franchise Tax Board, Cal. Ct. App., Second App. Dist., Div. Four, No. B081329 (4/22/96).

(24) Bensusan Restaurant Corp. v. King, 96 Civ. 3992 (9/9/96).

(25) Tech. Ass't Advisement 96(C)1-001 (5/1/96).

(26) Fulton Corp v. Janice H. Faulkner, 116 Sup. Ct. 848 (1996).

(27) See Ga. Code Section 48-6-27(a)(1)(5), effective for tax years after 1995.

(28) Herschel St. Ledger v. Rev. Cabinet, 912 SW 2d 34 (1995), rev'd, No. 94-SC-468-DG (1/30/97).

(29) See Herskovitz, Lux and Rabun, "Tax Planning After the Small Business Job Protection Act," 28 The Tax Adviser 20 (Jan. 1997).

(30) See FTB Notice 96-5 (12/6/96).

(31) 61 Pa. Code, Ch. 9, Section 9.16.

(32) Dow Hydrocarbons & Resources, Inc. v. John N Kennedy, Sec'y of the Dep't of Rev. and Tax'n, La. Dist. Ct., Parish of East Baton Rouge, No. 412, 485 (7/25/96).

(33) E.I. du Pont de Nemours E Co. v. State Tax Ass'r, 675 A2d 82 (1996).

(34) Appeal of Morton Thiokol, 864 P2d 1175 (1993).

(35) Perini Corp. v. Comm'r of Rev., 419 Mass. 763 (1995).

(36) Perini Corp. v. Comm'r of Rev., Ma. Sup. Jud'l Ct., Suffolk Cty., C.A. No. 93-393, SJC-06657 (5/13/96), supplementing id.

(37) Ch. 418 (AB 2724), Laws 1995.

(38) GTE v. Rev. Cabinet, Commonwealth of Ky., Ky Sup. Ct., No. 94-SC-168-DG (12/22/94).

(39) Great Northern Nekoosa Corp. v. State Tax Ass'r, Maine Sup. Jud'l Ct., No. Ken-95-205 (4/29/96), rev'g Maine Super. Ct., No. CV-93-615 (3/3/95).

(40) See TSB-M-96(4)R (8/21/96).

Executive Summary

* A number of states have jumped on the Geoffrey bandwagon by enacting regulations or rulings taxing out-of-state corporations licensing intangibles to in-state business.

* Some states have enacted specific exemptions from doing business for out-of-state customers of in-state printing services.

* A state may not recognize an S corporation formed after enactment of the SBJPA if the state has not yet adopted a post-SBJPA version of the IRC's S provisions.