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Current corporate income tax developments.


* The U.S. Supreme Court's holding in South Central Bell Telephone spawned a host of new Alabama tax legislation.

* South Dakota and New Mexico offered amnesty programs.

* A number of states increased the weightings of the apportionment formula sales factor.

This two-part article discusses a plethora of recent state developments issued in the corporate income tax area. Part I, in the last issue, addressed nexus and tax base; Part II examines apportionment and administration issues, as well as other income and non-income tax developments.

During 1999, an overwhelming number of state statutes were added, deleted or modified; court cases were decided; regulations were proposed, issued and modified; and bulletins and rulings were issued, released and withdrawn. Part I of this two-part article, in the last issue, focused on some of the more interesting items in the corporate income tax areas of nexus and tax base. Part II, below, discusses apportionment, administration and other significant income tax and nonincome tax developments.


A multistate corporation's 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. However, over the past several years, legislative changes to the apportionment formula have become common; more than half of the states now accord more weight to the sales factor than to the payroll or property factors. 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 jurisdiction, but generally provides tax relief for in-state corporations. 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.

* Arizona

Entities investing liquid assets held for use in a business may invest and reinvest these funds in a number of short-term investments throughout the tax year. According to the Arizona Department of Revenue (DOR), including the return of principal in the sales factor will not fairly apportion income from these investments, because the same principal investment may be included numerous times.(39) Based on A.R.S. [sections] S43-1148 and A.A.C. rule R15-2-1145(A)(7), which provide for modification of the apportionment factors to fairly reflect the taxpayer's business activity in Arizona, the DOR ruled that, when income from the investment and reinvestment of short-term securities is included in the sales factor, only the net gain is included if inclusion of total gross receipts in the factor does not fairly reflect the taxpayer's income-producing activity in the state.

* California

In Huffy Corp.,(40) the California State Board of Equalization (SBE) re-adopted the Joyce(41) rule (and overruled Finnigan(42)) to promote uniformity of the Uniform Division of Income for Tax Purposes Act and to more fairly reflect the fundamental principles of combined reporting. However, renewed implementation of the Joyce rule applies only to income years beginning on or after the date of the opinion (April 22, 1999).

* California

In Deluxe Corp. v. Franchise Tax Board (FTB),(43) a superior court held that the two Finnigan decisions are sound and that the apportionment methodology in Notice 90-3(44) is fairly calculated to assign to California that portion of net income reasonably attributable to the business done in the state. According to the court, this conclusion remains true even if the FTB reverts to the Joyce approach in subsequent years.

* Massachusetts

Under amended 830 CMR [sections] 63.38.1, the Commissioner may re-attribute the payroll of affiliated corporations to prevent distortions in the payroll factor. The revised regulation provides that the Commissioner may require compensation paid to an employee of a corporation that is a member of an affiliated group (as defined in Sec. 1504) to be included in the payroll factor of the group member for which the employee performed an amount of services greater than the amount of services he performed for any other group member (regardless of which group member actually paid the compensation).

This regulation also addresses leased employees. Compensation paid for personal services rendered by leased employees is includible in the payroll factor of the corporation that is the recipient of the leased employee's services. Compensation for personal services rendered by leased employees to client companies is excluded from the payroll factor of employee leasing companies.

* Minnesota

According to HF 2420, Laws 1999, effective for tax years beginning after 2000, the sales factor weighting is increased to 75%; the property and payroll factors are reduced to 12.5% each. The current formula weighting is 70% sales, 15% property and 15% payroll.

* New Hampshire

HB 572, Laws 1999, permanently established the double-weighted sales factor of the apportionment formula. Under prior law, the sales factor was scheduled to be reduced from a double weighting to a 1.5 weighting, effective for tax periods ending after June 30, 1999.

* New Jersey

The tax court held that a manufacturer's sales that were drop-shipped directly to an affiliated distributor's out-of-state customers had to be included in the numerator of the sales factor, because the taxpayer and the distributor were located in New Jersey.(45) This decision has been appealed.

* New Mexico

Under HB 178, Laws 1999, manufacturers can elect to apportion income using a double-weighted sales factor until Dec. 31, 2002. Under prior law, this option was scheduled to expire for tax years beginning after 1999.

* Oregon

The state supreme court affirmed the Oregon Tax Court's decision that a company may include gross receipts from its investment securities in the sales factor when apportioning income for corporate excise tax purposes.(46)

* Pennsylvania

According to SB 557, Laws 1999, the sales factor is triple-weighted (60%) for tax years beginning after 1998. Under prior law, the sales factor was double-weighted.

* Pennsylvania

A commonwealth court affirmed the Board of Finance and Revenue's order that dock sales (i.e., sales to out-of-state purchasers who pick up the purchased property at the company's Pennsylvania loading dock) are included in the numerator of the Pennsylvania sales factor.(47)

* Virginia

Under HB 1818, Laws 1999, the sales factor for general corporations is double-weighted for tax years beginning after 1999. Under prior law, each of the factors in the apportionment formula was evenly weighted.

Factor Relief

* Maine

Maine Revenue Services explained how a corporation with dividends from unitary foreign affiliates included in its Maine taxable income may claim apportionment factor relief on its state corporate income tax return.(48) The amount of factor relief, if any, is calculated by first determining the corporation's Maine taxable income, using the following three methods: (1) Maine's statutory "domestic" system, including the appropriate amount of foreign-source dividends; (2) worldwide combination; and (3) Maine's statutory system, but excluding dividends from unitary foreign affiliates. Tentative worldwide taxable income ((2) above) establishes a ceiling on the corporation's taxable income for the year. If (1) above is less than (2) above, factor relief will not be provided. If (1) above exceeds (2) above, factor relief is warranted sufficient to reduce the corporation's taxable income to the greater of (a) taxable income using worldwide combination ((2) above) or (b) taxable income using Maine's statutory system, but excluding dividends from unitary foreign affiliates ((3) above).

* New Hampshire

The state supreme court held that the state's water's-edge apportionment formula does not violate the Commerce Clause.(49) The state's water's-edge formula included royalty and interest payments received from foreign subsidiaries in the taxpayer's tax base, while excluding the property, payroll and sales of the foreign subsidiaries in the apportionment factor. The court held that, under the water's--edge combined reporting method, only the domestic members are treated as a unitary business, the income of which is apportionable and taxable by New Hampshire. Thus, the proper comparison for determining whether discrimination existed was between foreign subsidiaries and unrelated domestic entities. Using this comparison, the court found that payments from foreign subsidiaries are treated the same as payments from unrelated domestic entities, so there was no discrimination. The court thus rejected the taxpayer's argument that New Hampshire's apportionment formula violates the Commerce Clause.



* New Mexico HB 31, Laws 1999, required the Taxation and Revenue Department to conduct a temporary tax amnesty program. All penalties and interest were waived during the amnesty period (Aug. 16-Nov. 12, 1999).

* South Dakota

The state implemented a tax amnesty program from April 1-May 15, 1999. Taxpayers that had been audited or received audit notification were not eligible.

Voluntary Disclosure Programs

* North Carolina

The DOR issued a memorandum(50) announcing its revised voluntary disclosure program, which reduces the voluntary disclosure period and changes the DOR's internal procedures for handling voluntary disclosure requests. Under the revised program, the voluntary disclosure period is the current year, plus the back three years. (Under the prior program, the period was the current year, plus the back five years.) The reduction in the disclosure period applies to voluntary disclosures made after April 13, 1999 and to all voluntary disclosures pending as of that date. The program applies to any tax administered by the DOR and to any type of domestic or foreign taxpayer subject to North Carolina tax. It does not apply to a taxpayer registered for payment of a tax but who fails to file a return, nor to a taxpayer who files a return, but underreports the tax due thereon.


* Alabama

An administrative law judge ruled that a notice of appeal must be mailed or hand-delivered--not faxed--within the time prescribed.(51)

* Arkansas

HB 1626, signed into law as Act 1277, Laws 1999, permits, in the administration of any state tax law, the director to use proper and reasonable audit methods, including the use of sampling. However, if sampling is to be employed as an audit method, the taxpayer's consent to the sampling technique must be obtained at the audit's commencement.

* Florida

The first district court of appeals ruled that interest assessed by the DOR was inappropriate after a Federal audit adjustment, because a timely state amended return had been filed.(52) The taxpayer had timely filed an amended Florida income tax return after certain IRS audit adjustments. The Florida DOR assessed the taxpayer interest from the time the tax returns were originally due. The court held that a return is considered timely filed if filed within 60 days of an IRS adjustment that was agreed to and finally determined for Federal income tax purposes. The court found that, because the returns were timely filed (within 60 days), the taxpayer owed no interest.

* Massachusetts

Effective Jan. 15, 1999 under Acts of 1998, Chapter 485, the DOR has dispute resolution authority much earlier in the process. An appeal before the Appellate Tax Board (ATB) is no longer required for the DOR to have authority to settle a case. Two requirements must be met, however. First, the Commissioner must find that the settlement is in the state's best interest, taking into account potential hazards of litigation and the likelihood of a finding of liability against the taxpayer; second, the Commissioner and the taxpayer must agree to the settlement in writing.

* Massachusetts

During 1999, the "pay to play" provisions, which required taxpayers to pay amounts in dispute while appealing assessments, were repealed.(53) Effective July 1, 1999, a taxpayer is not required to pay, and the DOR may not involuntarily collect, certain taxes if the taxpayer is contesting the amount of tax due at the DOR, ATB or a probate court. The taxpayer may also delay paying any amount determined not to be due by the ATB or probate court if an appeal is taken from a decision. These provisions apply only to an assessment (or portion thereof) in dispute.

* Montana

SB 53, signed into law as Chapter 68, requires taxpayers to file amended state returns if their Federal taxable income is changed or corrected. Effective for tax years beginning after 1998, taxpayers are required to file amended Montana returns within 90 days after receiving a notice from the IRS changing or correcting their Federal taxable income. Previously, taxpayers were required to report the change or correction only to the DOR.

* Oregon

SB 257, signed into law as Chapter 74, requires taxpayers to notify the DOR of changes to income tax returns filed with other states, that result in a change in the taxpayer's Oregon taxable income or tax liability. The taxpayer must file an amended return within 90 days of filing an amended income tax return of another state that affects the taxpayer's Oregon tax liability. In addition, the statute of limitations (SOL) for assessing Oregon tax related to a change in liability owed to another state is open for the later of two years after the DOR is notified by the taxpayer or other state or three years after the return was fried. The new law also requires that taxpayers furnish the DOR with other states' audit reports, on request.

Other Important Developments

Corporate Tax Rates/Exemptions

* Arizona

HB 2007, Laws 1999, contained conditional tax cuts. Triggers, based on excesses over forecast revenues or each year's surplus, will determine the tax reductions to be made in fiscal 2000 and 2001. The only guaranteed tax cut is a $40 million reduction in the state vehicle license tax over two years ($20 million each year). If actual revenues exceed forecast revenues by $8 million, the first triggered tax reduction (in the mining severance tax) would take effect. The next trigger would result in a corporate income tax rate reduction from 8% to 7%, 0.25% at a time, depending on the amount of the surplus. If another $32 million in surplus is realized above the $8 million, the total rate reduction will take effect in the following year. Thus, if the surplus reaches $40 million for fiscal 2000, the corporate income tax rate reduction will take effect in fiscal 2001. The third triggered reduction would eliminate the current $500,000 cap on the research and development income tax credit; the fourth would lower the personal property tax valuation floor.

* Colorado

Under HB 1207, Laws 1999, effective for tax years beginning after 1998, the state income tax rate on individuals, estates, trusts and corporations is reduced from 5% to 4.75%.

* District of Columbia

Under the D.C. Tax Parity Act of 1999, if certain general fund thresholds are met, the current 9.5% corporate franchise tax will be reduced to 9% for years beginning after 2002 and to 8.5% for years beginning after 2003. For tax years beginning after 2002, the 5% additional corporate franchise surtax will be eliminated. (The current franchise tax, including the surtax, is 9.975%.)

* New Hampshire

Various new taxes and tax increases will provide education funding, under HB 112, Laws 1999. In addition to enacting a statewide property tax, the business profits tax was increased by 1%; the business enterprise tax was increased by 0.25%.

* New York

In 1998, the corporate franchise tax rate was reduced from 9% to 7.5%. In 1999, tax cuts were extended to the banking and insurance industries by Chapter 407, Laws 1999. The current 9% rate will drop to 8.5% for tax years beginning after June 30, 2000; to 8% for tax years beginning after June 30, 2001; and to 7.5% for tax years beginning after June 30, 2002. In addition, the cap on total tax liability for property and casualty companies is reduced to the same rate currently applicable to life insurance companies. The cap for property and casualty companies will drop to 2.4% for tax years beginning after June 30, 2000; to 2.2% for tax years beginning after June 30, 2001; and to 2% for tax years beginning after June 30, 2002.

* New York

Chapter 407, Laws 1999, also reduced the general corporate franchise tax (Article 9-A) alternative minimum tax rate from 3% to 2.5%.

* Texas

According to SB 441, Laws 1999, effective for reports due after 1999, taxpayers with less than $150,000 in gross receipts for earned surplus and taxable capital purposes are exempt from paying franchise tax and filing franchise tax returns. However, these taxpayers can be required to file an abbreviated information report detailing the amount of their gross receipts.

Trusts, Passthrough Entities and Owners

* Connecticut

The state supreme court ruled that the state's tax on the undistributed taxable income of resident testamentary and inter vivos trusts does not violate the Due Process Clause or the Commerce Clause.(54) Each of the trusts was a resident trust as defined by the applicable Connecticut tax statute. However, it was undisputed that Chase Manhattan Bank, acting as trustee, maintained no presence in Connecticut, no aspect of trust administration was conducted there and, except for this court proceeding and certain probate proceedings, had not been the subject of any judicial or administrative proceeding in any Connecticut forum. The assets of each trust consisted solely of cash and securities held in accounts of a New York bank, no asset of any trust was located in Connecticut, and no trust income was earned there. The court ruled that Connecticut's tax did not violate the Due Process Clause, because there were sufficient contacts between the trusts and the state to permit the state to treat the trusts as state domiciliaries.

* Massachusetts

The DOR reiterated that the state follows the check-the-box regulations only for limited liability companies (LLCs); the treatment of all other unincorporated entities is unaffected by the Federal check-the-box rules.(55)

* Michigan

The state conforms to the Federal check-the-box regulations for single business tax (SBT) purposes.(56) However, a Federal entity classification election has no bearing on a person subject to Michigan income tax withholding and/or sales and use taxes. If the person making sales in Michigan is not required to have a separate Federal employer identification number, the DOR will assign a treasury identification number to the employer withholding and/or sales and use tax account.

* New Jersey

The state supreme court overturned a longstanding judicial doctrine that a taxpayer's New Jersey gain on the disposition of property is measured by his Federal basis in the property.(57) The taxpayer had sold a partnership interest for which he had previously deducted losses for Federal tax purposes that were not allowed for New Jersey purposes.

* Ohio

In two separate cases, the state supreme court affirmed that Ohio can subject to tax a nonresident shareholder of an S corporation doing business in the state.(58)

* Pennsylvania

P.L. 26, No. 4 (Act 4) eliminated the passive income test for S corporations. Accordingly, the state now conforms to the Federal S corporation election rules. Federal S corporations that previously could not elect S status for state purposes because of the passive income test can make a state S election for tax years beginning after 1998.

* Tennessee

In a surprise move, the general assembly, in SB 1806 and HB 1676, Laws 1999, extended the state's excise tax (6% of net earnings) and franchise tax ($0.25 per $100 of net worth) to passthrough entities having limited liability (i.e., LLCs, limited liability partnerships and limited partnerships); general partnerships and sole proprietorships are not taxed.

Other Issues

* California

An FTB individual income tax assessment was deemed invalid because the FTB failed to maintain copies of the taxpayer's returns for the periods assessed.(59) The taxpayer completed an IRS audit and, as required, notified the FTB of the IRS adjustments. The FTB requested additional information and copies of the California tax return filed for 1983, the year at issue. The FTB did not have a copy of the return because it did not maintain returns for longer than the SOL period. The FTB issued an assessment estimating the taxpayer's 1983 income. The trial court concluded that the FTB's notice of proposed assessment was invalid, because a deficiency could not be "determined" without a review of the taxpayer's return, and the notice of proposed assessment had been prepared without such a review. On appeal, the court of appeal concluded that the plain language of the California statutes requires the FTB to consult the taxpayer's return before issuing a deficiency notice; because that had not been done, the assessment was invalid.

* Georgia

HB 438, Laws 1999, allows a corporate taxpayer to elect to assign credits for which it is eligible to another taxpayer in its affiliated group, as defined in Sec. 1504(a). The credit assignor and recipient are not required to file a Georgia consolidated return. A credit must be assigned in its entirety; once an election is made, it is irrevocable. However, if the credit assignor and recipient cease to be members of the same affiliated group, any carryover attributable to the unused portion of the credit is transferred back to the assignor.

* Maryland

The court of appeals affirmed that the Comptroller does not have the authority to assess additional income tax under Sec. 482.(60) The Comptroller assessed tax resulting from imputing income from intercompany accounts between the taxpayer and its subsidiaries. According to the court, the Comptroller generally must accept the taxable income reported on a corporation's Federal consolidated return, subject to specific Maryland modifications provided under state law. The court held that neither those modifications nor the apportionment provisions grant the Comptroller any power similar to that contained in Sec. 482 to allocate or impute income for tax enforcement purposes. The court further held that those provisions do not authorize the Comptroller to enforce Sec. 7872 beyond its terms to generate state income tax from income legitimately not reported on the taxpayer's Federal return.

* Maryland

The state tax court addressed a subsidiary's ability to take deductions allocated to it by its parent for state corporate income tax purposes.(61) The court ruled in the taxpayer's favor, holding that the deductions were proper because the related expenses were actually incurred by the parent and allocated to the subsidiary on an arm's-length basis. The court also ruled that an agreement entered into by the taxpayer with the IRS extended the state SOL.

* Oregon

The state tax court ruled that a taxpayer's Oregon unitary income includes the income of a foreign insurance company included in the taxpayer's Federal consolidated return, even though the insurance company is not subject to Oregon excise tax.(62)

Significant Nonincome Tax Developments

* Illinois

The Seventh Circuit affirmed a district court decision holding that the Employee Retirement Income Security Act of 1974 preempts the Illinois unclaimed property law, which requires pension plans to transfer to the state benefits payable but unclaimed by plan beneficiaries within five years.(63)

* Alabama

The U.S. Supreme Court declared the Alabama Foreign Corporation Franchise tax unconstitutional, because it impermissibly discriminates against interstate commerce in violation of the Commerce Clause.(64) The Court did not address the issue of the appropriate remedy by the state; the case was remanded to the Alabama Supreme Court for further proceedings. No remedy is yet available to taxpayers.

* Alabama The Governor signed into law four bills created to replace the estimated $120 million in annual franchise tax revenue lost in light of the above decision. The package of four bills constitute a "replacement tax" consisting of (1) a short-term "bridge tax" and (2) a proposal for a long-term solution, requiring a constitutional referendum, that would raise the corporate income tax and the financial institution excise tax rates.(65) The replacement tax is referred to as the "Alabama Business Privilege and Corporate Shares Tax Act of 1999." It consists of both a business privilege tax and an annual shares tax; following is a brief discussion of each. It is expected that technical corrections to the legislation will follow in an upcoming legislative session.

The new business privilege tax is a net worth tax imposed on corporations, limited liability entities and disregarded entities (as defined under the new law). Net worth is defined differently for corporations, limited liability entities, disregarded entities and business trusts classified as corporations. Additions (including certain related-party debt) and exclusions from net worth are also provided. Net worth is apportioned to Alabama in the same manner as prescribed for apportioning income. The rate of tax is intended to be based on ability to pay and, accordingly, is graduated based the taxpayer's Federal taxable income. The rates range from $0.25 to $1.75 for each $1,000 of net worth in Alabama, with a $100 minimum tax. The maximum tax is $15,250 for 2000 and $15,000 for subsequent tax years. However, the maximum tax for financial institutions, insurance companies and public utilities is $3 million; the maximum tax for real estate investment trusts (REITs) is $500,000. If the constitutional amendment containing a corporate income tax rate increase is passed, the maximum tax for public utilities and REITs will be $15,000.

The new annual corporate .share tax (now imposed at the entity level! applies to all corporations organized under Alabama law or doing business there. However, the following are exempt: financial institutions, insurance companies, public utilities and REITs. The annual shares tax, which applies only to corporations, is substantially different from the shares tax previously applicable to Alabama corporations; essentially, it is an apportioned net worth tax. In computing the tax base, certain additions and exclusions from net worth are allowed, some of which are similar to additions and exclusions allowed under the former shares tax. The annual shares tax base is apportioned in the same manner as apportioning income to Alabama. The tax rate is $5.30 per $1,000 of the taxable shares base and cannot exceed $500,000 for any taxpayer. If the constitutional amendment to raise the corporate income tax rate is ratified, the rate for the tax year beginning Jan. 1, 2001 will be $1.35 per $1,000 of the taxable shares base and will not exceed $125,000 for any taxpayer. Further, on passage of the constitutional amendment, the shares tax will be repealed for periods beginning after 2001.

The passage of the proposed constitutional amendment will affect not only the business privilege tax and the annual shares tax, but also result in significant changes to the corporate income tax. If the constitutional amendment is ratified, the corporate income tax rate will increase to 6.5% from 5%; the financial institution excise tax rate will increase to 6.5% from 6%. The Federal income tax deduction will be retained. In addition, Alabama will use Federal taxable income as the starting point in computing state taxable income, a significant change from current law. The Alabama income tax changes are effective for tax years beginning after 2000.

The following taxes are repealed: the property tax on domestic shares; the admission tax on foreign corporations; permit fees on domestic and foreign corporations; and the registration of securities tax.

* Massachusetts

For tax years beginning after 1998, domestic and foreign corporations can choose either of the two "tangible or intangible property corporation classification" formulas from Schedule B of Forms 355A and 355B, for current and future tax years.(66) Thus, a domestic or foreign corporation can annually choose either the formula for domestic corporations or for foreign corporations. In addition, domestic and foreign intangible property corporations are permitted to choose either of the two net worth formulas from Schedule D of Forms 355A and 355B, in calculating their tax liability for current and future years. Thus, a domestic or foreign corporation can annually choose either the formula for domestic corporations or for foreign corporations. For tax years beginning before 1999, a corporation wishing to so choose must file an application for abatement with the Commissioner.

* Michigan

Sales made to states in which a taxpayer has a physical presence sufficient to establish substantial nexus should not be "thrown back" to Michigan.(67) The taxpayer, a Michigan corporation, employed a sales representative who lived in Michigan and solicited sales in 17-25 other states, spending about 155 days per year in those states. In addition, the taxpayer's president spent between two and four days a year in each of eight states, calling on the taxpayer's major customers. The "economic activities" test was applied to the taxpayer's activities. Because the taxpayer's activities in states outside of Michigan (sales visits by the taxpayer's president to major customers, economic activities by the sales representative and the number of sales calls) constituted sufficient physical presence under state case law, it was ruled that the taxpayer had established substantial nexus in certain states. Thus, the taxpayer had the right to apportion its sales to those states; such sales were not required to be thrown back to Michigan.

* Michigan

Effective for tax years beginning after 1999, P.A. 115 defines the tax base of a foreign person, regardless of taxable status under the Internal Revenue Code (IRC), to include gross income attributable to business activities within the U.S., plus gross income derived from other sources within the U.S., less deductions allowed by the IRC. It applies the usual SBT adjustments to a foreign person's tax base, but provides a separate definition for compensation. It also provides that a foreign person will calculate its apportionment factors using only the U.S. portion of its factors to determine its denominator. Foreign corporations will not be permitted or required to file a consolidated SBT return under the new law.

* Michigan

The state court of claims found that the current version of the SBT capital acquisition deduction discriminates both on its face and in its effect on interstate commerce and therefore is unconstitutional.(68) The state plans to appeal.

* Michigan

Beginning Jan. 1,1999, HB 4745, Laws 1999, reduced the current SBT rate of 2.3% by 0.1% each January 1, thereby recalculating the SBT rate each year. The reduction is contingent on a budget surplus of $250 million each fiscal year.

* Pennsylvania

A commonwealth court held that, in certain circumstances, the state's method of computing a taxpayer's foreign franchise tax is unfair and entitles the taxpayer to special apportionment relief.(69) The taxpayer challenged the state's method of determining foreign franchise tax liability, which uses (1) a tax base, a portion of which consists of historical net earnings including dividend income from subsidiaries and (2) a net worth computed on a consolidated basis, but uses an apportionment factor computed on a separate-company basis. The taxpayer proved that the current method used in Pennsylvania overstated its foreign franchise tax liability by 44.5%, when compared with the liability computed using the current computation of the tax base and a consolidated apportionment factor. The court held that this disparity mandated that the taxpayer be provided with special apportionment relief. The court did not specify the precise form of special relief; it left that determination to the DOR.

* Pennsylvania

The state supreme court held that the capital stock/franchise tax manufacturing exemption facially discriminates against interstate commerce.(70) The taxpayer is a Pennsylvania corporation that conducts manufacturing operations at plants located both within the state and in other states. All of its manufacturing operations are administered from a Pittsburgh headquarters. The company computed its franchise tax liability by multiplying its tax base by an apportionment factor calculated using the average of three ratios: tangible personal property in the state to tangible personal property everywhere; payroll in the state to payroll everywhere; and sales in the state to sales everywhere. In addition to exempting property, payroll and sales directly related to its in-state manufacturing operations, the taxpayer exempted the value of property and payroll related to the administration of all its manufacturing operations in computing its apportionment ratios. On audit, the DOR increased the taxpayer's apportionment ratios to include property and payroll attributable to administering plants outside the state. The state supreme court reversed the lower courts' decisions and concluded that, by employing the manufacturing exemption to the capital stock tax as a means of inducing other business operations (i.e., manufacturing) to be performed in Pennsylvania, the law unconstitutionally forecloses "tax neutral decisions" and affords preferential treatment to corporations that engage in manufacturing activities in Pennsylvania.

On remand, the commonwealth court concluded that the manufacturing exemption is unconstitutional and suggested retroactive and prospective remedies.(71)

* Pennsylvania

SB 557, Laws 1999, reduced the capital stock/foreign franchise tax from 11.99 mills to 10.99 mills for tax years beginning after 1998. In addition, the minimum capital stock/foreign franchise tax liability is reduced to $200 from $300 for tax years beginning after 1998.

* South Carolina

The state supreme court held that Charleston's business license ordinance is constitutional.(72) The court noted that under the McCarran-Ferguson Act (Act), if the state enacted a tax on gross premiums (similar to that imposed by Charleston), the tax would be immune from Commerce Clause scrutiny. The court explained that the state had delegated this type of taxing authority to Charleston by enacting S.C. Code Ann. [sections] 38-7-160, which specifically permits municipalities to collect a business license fee or tax based on insurance premiums collected in the municipality or realized from risks located therein. The court concluded that the authority granted to the states under the Act includes the power to enact such a statute; thus, Charleston's business license ordinance is constitutional.

* Washington

The state supreme court ruled that, as cured by 1987 remedial legislation, Washington's business and occupation (B&O) tax on interstate sales and manufacturing is not a nullity and that the remedial legislation applies retroactively.(73) In Tyler Pipe Industries Inc. v. DOR,(74) the U.S. Supreme Court found Washington's B&O tax, as it applies to interstate sales and manufacturing, violated the Commerce Clause; the decision applied retroactively. Within two months of that decision, the state legislature responded by enacting remedial legislation, which provided that all persons engaged in manufacturing activities in Washington have to pay a manufacturing tax; all persons engaged in selling in Washington have to pay a selling tax. Persons paying a selling tax may claim a multiple activities tax credit (MATC) for any manufacturing tax paid to Washington (or any other jurisdiction) on the same product. Similarly, persons paying a manufacturing tax and selling out-of-state can take an MATC against that tax for selling tax paid on the same product. According to the court, the 1987 MATC legislation addressed the constitutional defects in a fashion specifically suggested by the U.S. Supreme Court; thus, as it has previously done, the court rejected the taxpayer's Commerce Clause and Due Process challenges to the MATC. The court found that the 1987 legislative remedy for the unconstitutionality of Washington's B&O tax system applied retroactively, like Tyler Pipe.

(39) Ariz. Corp. Tax Ruling 99-4 (5/25/99).

(40) In the Matter of the Appeal of Huffy Corp., Cal. SBE, No. 99-SBE-005 (4/22/99).

(41) Appeal of Joyce, Inc., Cal. SBE, No. 066-SBE-069 (11/13/66), which held that, in computing the numerator of the sales factor for sales into California, P.L. 86-272 must be applied on a corporate entity basis, not on a unitary group basis.

(42) Appeal of Finnigan Corp. (Finnigan I), Cal. SBE, No. 088-SBE-022 (8/25/88), which held that, in computing the numerator of the sales factor for sales to other states, P.L. 86-272 must be applied on a unitary group basis, not on a corporate entity basis. Appeal of Finnigan Corp. (Finnigan II), Cal. SBE, No. 088-SBE-022A (1/24/90), stressed that Finnigan I changed only an apportionment rule, not the state's jurisdiction to tax particular corporations.

(43) Deluxe Corp. v. FTB, Sup'r Ct., Cnty. of San Francisco, No. 991237 (4/29/99).

(44) FTB Notice 90-3 (6/8/90).

(45) Stryker Corp. v. Director, Div. of Tax'n, NJ. Tax Court, No. 004852-96 (8/16/99).

(46) Sherwin-Williams Co. v. DOR, Ore. Sup. Ct., No. S46023 (1/27/00).

(47) Gilmour Mfg. Co. v. Commonwealth of Pa., 426 F.R. 1995 (1998).

(48) Maine Tax Alert, Vol. 9, No. 4 (September 1999).

(49) Caterpillar Inc. v. N.H. Dep't of Rev. Admin., N.H. Sup. Ct., No. 97-779 (10/25/99).

(50) N.C. Memorandum (4/4/99).

(51) Nash v. State of Ala. DOR, Ala. Admin. Law Div., No. P. 98-513 (5/5/99).

(52) Barnett Banks, Inc. v. DOR, Fla. Dist. Ct. of App., No. 98-4104 (8/10/99).

(53) See Mass. Admin. Bull., Vol. 15, No. 3 (9/1/99).

(54) Chase Manhattan Bank v. Gene Gavin, Comm'r of Rev. Svces., 733 A2d 782 (1999), cert. den.

(55) Mass. DOR, Letter Ruling 99-13 (6/24/99).

(56) Mich. Kev. Admin. Bull. t999-9 (6/24/99).

(57) Sidney Koch v. Dir., Div. of Tax'n, N.J. Sup. Ct., No. A-135-97 (1/14/99).

(58) Dupee v. Tracy, Tax Comm'r, Ohio Sup. Ct., No. 98-255 (4/28/99); Agley v. Tracy, Tax Comm'r, 719 NE2d 951 (1999).

(59) John E. Wertin v. FTB, Cal. Ct. of App., Nos. B114114 and B117076 (12/21/98).

(60) Comptroller of the Treasury v. Gannett Co. Inc., 741 A2d 1130 (1999).

(61) America's Mortgage Servicing, Inc. v. Comptroller of the Treasury Compliance Div., Md. Tax Ct., Nos. C-95-0002-01 and C-95-0108-01 (4/22/99).

(62) State of Ore., Ex Rel., DOR v. Penn Independent Corp., Ore. Tax Ct., No. 4321 (11/17/99).

(63) Commonwealth Edison Co. v. Sarah D. Vega, 7th Cir., 4/13/99.

(64) South Central Bell Telephone Co. v. Alabama, 526 US 160 (1999).

(65) See H1, 2d Spec. Sess. (Act 99-664); H3, 2d Spec. Sess. (Act 99-600); and H4, 2d Spec. Sess. (Act 99-665).

(66) Mass. DOR Directive 99-1 (1/4/99).

(67) Gear Research, Inc. v. Mich. Dep't of Treasury, Mich. Tax Tribunal, No. 227850 (9/24/99).

(68) Jefferson Smurfit Corp. v. Rev. Div., Dep't of Treasury, State of Michigan, Mich. Ct. of Cls., No. 98-17140-CM (11/24/99).

(69) Unisys Corp. v. Commonwealth of Pa., 726 A2d 1096 (1999).

(70) PG Industries, Inc. v. Commonwealth of Pa., Pa. Sup. Ct., No. 87 (6/17/99).

(71) PPG Industries, Inc. v. Commonwealth of Pa., Commonwealth Ct. of Pa., No. 2355 C.D. 1987 (11/30/99).

(72) City of Charleston v. Government Employees Insurance Co., S. Car. S. Ct., No. 24894 (2/8/99).

(73) W.R. Grace v. State of Wash., DOR, Wash. Sup. Ct., No. 64335-1 (4/1/99).

(74) Tyler Pipe Industries, Inc. v. DOR, 483 US 232 (1987).

Karen J. Boucher, CPA Senior Tax Manager Arthur Andersen LLP Milwaukee, WI
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Title Annotation:part 2
Author:Boucher, Karen J.
Publication:The Tax Adviser
Geographic Code:0JSTA
Date:Apr 1, 2000
Previous Article:Changing an impermissible LIFO method.
Next Article:The courts look at sec. 6672 TFRP.

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