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Treaty Application for Companies in a Group (FM nr. 178) 2022/5.3.5.2
5.3.5.2 Formulary apportionment in the United States: highlights of the system
L.C. van Hulten, datum 06-07-2022
- Datum
06-07-2022
- Auteur
L.C. van Hulten
- JCDI
JCDI:ADS659366:1
- Vakgebied(en)
Omzetbelasting / Plaats van levering en dienst
Voetnoten
Voetnoten
S. Mayer, Formulary Apportionment for the Internal Market, Amsterdam: IBFD 2009, par. 3.2.
J.C. Finch, ‘The Apportionment of Multistate and Multinational Corporate Income for Tax Purposes’, Bulletin for International Fiscal Documentation 1984, vol. 38, no. 2, p. 57.
See par. 2.4.4.3.
J.M. Weiner, ‘Combined Reporting and the Unitary Business Principle: A Doctrine That Has Not (Yet) Made the Atlantic Crossing’, The State and Local Tax Lawyer. Symposium Edition 2008, p. 181.
E.D. Siu, M.I. Nalukwago, R. Surahmat & M.A.P. Valadão, ‘Unitary Taxation in Federal and Regional Integrated Markets’, ICTD Research Report 2014, no. 3, par. 1.5.1.
South Dakota v. Wayfair, Inc., 138 S.Ct. 2080 (2018).
E.g., by Indiana (S.B. 563 of the revised corporate income tax law of Indiana provides that ‘income derived from Indiana shall be taxable to the fullest extent permitted by the Constitution of the United States and federal law, regardless of whether the taxpayer has a physical presence in Indiana’).
See also the explanation of the Californian system in the next section.
E.D. Siu, M.I. Nalukwago, R. Surahmat & M.A.P. Valadão, ‘Unitary Taxation in Federal and Regional Integrated Markets’, ICTD Research Report 2014, no. 3, par. 1.5.3. See also S. Mayer, Formulary Apportionment for the Internal Market, Amsterdam: IBFD 2009, par. 3.2.4.3.
H.T. Duncan, ‘Relationships between Federal and State Income Taxes’, Washington DC: Federation of Tax Administrators 2005, p. 3.
Income arising from transactions and activities in the regular course of a taxpayer’s trade or business is considered to be apportionable income. Additionally, apportionable income includes income from tangible and intangible property, given that the acquisition, management and disposition of the property constitute integral parts of the taxpayer’s regular trade or business operations. Furthermore, ‘any income that would be allocable to this state under the Constitution of the United States, but that is apportioned rather than allocated pursuant to the laws of this state’ is considered to be apportionable income (Multistate Tax Compact - Model General Allocation & Apportionment Regulations, Regulation IV.1(a). Apportionable and Non-apportionable Income Defined. (1) Apportionment and Allocation, (2) Apportionable Income, (4) Transactional Test, (5) Functional Test).
Non-apportionable income is simply defined as consisting of all income other than apportionable income (Multistate Tax Compact - Model General Allocation & Apportionment Regulations, Regulation IV.1(a). Apportionable and Non-apportionable Income Defined. (1) Apportionment and Allocation, (7) Non-apportionable income).
The property factor consists of ‘all real and tangible personal property owner or rented by the taxpayer and used during the tax period in the regular course of the trade or business.’Examples of real and tangible personal property are: land, buildings, machinery, stocks of goods etc. If property is used in relation to non-apportionable income, the property should be excluded from the property factor. If property is used both in relation to apportionable income and non-apportionable income, it should be included in the factor only to the extent it is used in relation to the production of apportionable income (Multistate Tax Compact - Model General Allocation & Apportionment Regulations, Regulation IV.10.(a). Property Factor: In General).
The second factor in the Multistate Tax Compact apportionment formula is payroll. This factor should consist of the total amount paid by the taxpayer in the regular course of its trade or business for compensation during the tax period. How much is paid to employees is determined using the taxpayer’s accounting method (Multistate Tax Compact - Model General Allocation & Apportionment Regulations, Regulation IV.13.(a). Payroll Factor: In General).
The third and last factor in the Multistate Tax Compact apportionment formula is receipts (or sales). In this respect the term receipts means in principle all gross receipts derived by the taxpayer from transactions and activity in the regular course of the trade or business (Multistate Tax Compact - Model General Allocation & Apportionment Regulations, Regulation IV.15.(b). Receipts Factor: Denominator).
Multistate Tax Compact - Model General Allocation & Apportionment Regulations, Regulation IV.9. Apportionment Formula.
Multistate Tax Compact, Article IV. Division of Income, par. 9.
Multistate Tax Compact - Model General Allocation & Apportionment Regulations, Regulation IV.18.(a). Special Rules: In General. This can also be done on the initiative of the tax administrator.
This concerns airlines, construction contractors, publishing, railroads, television and radio broadcasting, trucking companies, telecommunications and ancillary service providers, bank holding companies and subsidiaries as well as financial institutions (Multistate Tax Compact - Model General Allocation & Apportionment Regulations, Regulation IV.18.(a). Special Rules: In General).
The United States’ practice of formulary apportionment consists amongst others of 46 different state systems of apportionment, a single federal statute and case law.1 The federal government and most states levy some form of corporate income tax. For state taxes, rather than separate accounting for determining the corporate profits, in most states a unitary taxation and formulary apportionment system is used. The system is used to protect against profit shifting between states, because the states would presumably not be able to satisfactorily administer transfer pricing.2
The unitary business principle governs the consolidation of business income of the various states. The states that apply unitary taxation/formulary apportionment do not use exactly the same definition of the term unitary business.3 In short, the unitary business reflects the integrated nature of a corporation that consists of multiple entities. To determine whether a unitary business exists, a subjective analysis of the interconnected economic relationships of the various parts of the entity is required.4
If there is no legal entity in a certain state, it should be established whether there is sufficient nexus to determine whether activities are taxable in that state. A sufficient nexus may be in place via economic activities or physical presence.5 In line with the United States Supreme Court judgment in the 2018 Wayfair-case,6 nexus is established when the taxpayer ‘avails itself of the substantial privilege of carrying on business in that jurisdiction’. Having physical nexus is not a requirement. The Wayfair judgment is a case regarding sales and use taxes. However, an economic nexus provision was adopted by various states for corporate income tax purposes afterwards.7
Tax base consolidation takes place either under a water’s edge or under a worldwide approach. Mandatory worldwide consolidation was abolished in the United States.8 Currently, both methods are used in the United States under certain circumstances.9
For the application of formulary apportionment in the United States, all 46 states that levy a tax based on corporate income take the federal taxable income as a starting point to compute the state tax due. Amongst others tax incentives offered by states lead to diverging tax base definitions.10
There is model legislation in the United States with respect to unitary taxation: the Multistate Tax Compact. This model legislation aims to promote uniformity of tax laws. In the approach to unitary taxation as included in the model, a distinction is made between apportionable and non-apportionable income. Both include gains and losses. The apportionable income is apportioned among jurisdictions using a formula.11 The non-apportionable income is allocated to one or more specific jurisdictions subject to express rules.12
The Multistate Tax Compact prescribes three elements that should be included in the apportionment formula: the property factor,13 the payroll factor14 and the receipts factor15 of the trade or business of the taxpayer.16 These factors should be given a weight, which can be defined by the state itself.17 This leads to a lot of diversity. Additionally, if income allocated via the formula does not fairly reflect economic reality, taxpayers have the possibility to petition for an alternative method of apportionment.18 Furthermore, the Multistate Tax Compact provides specific apportionment formulas for various industries.19
In summary, first the tax base should be determined applying a water’s edge or worldwide approach in line with the consolidation laws of a state. Subsequently, the tax base is divided into apportionable and non-apportionable income. Afterwards the non-apportionable income is allocated to one or more specific jurisdictions pursuant to certain rules, whereas the apportionable income is apportioned based on a formula.