Interstate Income Tax Allocation for Corporations involved in Interstate Commerce

Uniform Division of Income Tax Purposes Act

In 1959 Alaska adopted the Uniform Division of Income for Tax Purposes Act (UDITPA).  The  National Conference of Commissioners on Uniform State Laws drafted UDITPA in 1957 to bring unify state tax codes with respect to the interstate income tax allocations for corporations involved in interstate commerce.

The Multistate Tax Compact

In 1970 Alaska adopted the Multistate Tax Compact (MTC). The MTC restated the UDITPA with some minor changes. Alaska codified the MTC  at AS 43.19.010. Per AS 43.19.010, article IV, section 9, the portion of a business’s total income apportioned to Alaska is determined by “multiplying the income by a fraction, the numerator of which is the property factor plus the payroll factor plus the sales factor, and the denominator of which is three.” The property factor is the fraction of the taxpayer’s total property and the property attributable to the taxpayer’s business in Alaska; similarly, the sales and payroll factors are fractions of the taxpayer’s respective total sales and payroll attributable to the taxpayer’s business in Alaska.

Allocation Formula for Interstate Income Tax Allocation

Alaska Statute 43.19.010, article IV, section 18 permits DOR to adjust a taxpayer’s tax burden if the statutorily mandated apportionment does not “fairly represent the extent of the taxpayer’s business activity in this state.” Subsection 18(a) allows DOR to apportion the taxpayer’s income based on separate accounting, while subsection 18(c) allows DOR to add “one or more additional factors” to the apportionment formula. The statute effectively requires that any remedy DOR enforces under section 18 be “reasonable.”

Alaska Statute 43.20.144 modifies AS 43.19.010’s apportionment scheme for all taxpayers “engaged in the production of oil or gas . . . in this state or engaged in the transportation of oil or gas by pipeline in this state.”10 Alaska Statute 43.20.144(c) provides three different apportionment formulas for such taxpayers, depending on the nature of the taxpayer’s oil or natural gas business in Alaska. Under AS 43.20.144(c)(1), a taxpayer that only transports oil or gas in Alaska is subject to a two-factor formula based on property and sales. Under AS 43.20.144(c)(2), a taxpayer that only produces oil or gas in Alaska is instead subject to a two-factor formula based on property and extraction. Finally, under AS 43.20.144(c)(3), a taxpayer that both transports and produces oil or gas in Alaska is subject to a three-factor formula based on property, sales, and extraction.

Constitutional Challenges to Interstate Income Tax Allocation

Under the Due Process and Interstate Commerce Clauses of the United States Constitution, a state “may not tax value earned outside its borders.” The central inquiry is “whether the state has given anything for which it can ask return.” But the United States Supreme Court has long recognized that taxing multi-state companies using strict geographic accounting fails to account for “the many subtle and largely unquantifiable transfers of value that take place among the components of a single enterprise.” The unitary business/formula apportionment method of taxation is meant to remedy this problem. Under this method, a taxing state first identifies the unitary business of which the taxpayer’s in-state activities are a part and then apportions the income of this unitary business to the taxing state according to a set formula.

In order for a business to be unitary, and thus amenable to formula apportionment, there must be flows of value between the parent and subsidiary. The United States Supreme Court has distinguished these flows of value from the mere passive flow of funds that arises from any parent- subsidiary relationship. Three “factors of profitability” indicate a unitary business:

  1. functional integration,
  2. centralization of management, and
  3. economies of scale.

Unitary Business Activities Supports Interstate Income Tax Allocation

  1. In Container Corp. of America v. Franchise Tax Board, the United States Supreme Court held a paperboard company to be unitary with its subsidiaries where the parent provided the subsidiaries with loans and loan guarantees, occasional assistance in obtaining equipment and fulfilling personnel needs, and general oversight and guidance. I
  2. In Alaska Gold Co. v. State, Department of Revenue, the Alaska Supreme upheld a finding of functional integration where the parent approved capital expenditures greater than $100,000, handled salaries and payroll for executives, and guaranteed the subsidiaries’ lease obligations.  
  3. In Earth Resources Co. of Alaska v. State, Department of Revenue, the Alaska Supreme Court upheld a unitary business finding where the parent provided the subsidiary with loans and loan guarantees, a uniform pay scale, salary guidelines, and a uniform retirement plan. In each of these cases the courts examined the same sorts of administrative and financial services.
  4. And in Tesoro Corporations and Subs v. State, Department of Revenue, The Alaska Supreme Court upheld a unitary business finding where the parent exercised almost complete control over the credit facilities, budgeting, cash management, project selection, personnel, uniform services in the fields of environmental compliance and safety, information services and technology, internal auditing, legal affairs, insurance, risk management, purchasing, and accounting.

 

 Selection of Taxation Regime Requires More Planning than Identifing a lower Rate

Just because the accountants can identify a better tax scheme in the code doesn’t mean that you can take advantage of the code.  In Tesoro’s case the company wanted both the economies of scale in management and it wanted to reduce the taxes by more favorable allocations.  Unfortunately the presence of unitary business activities precluded the independent activity allocations.  Accordingly, they now face penalties and interest from taxes outstanding for more than a decade.