May 18, 2015
From KPMG TaxWatch
Recently, a South Carolina Administrative Law Court addressed whether a satellite television service provider’s receipts from providing television programming to South Carolina subscribers were included in the South Carolina sales factor numerator. The taxpayer argued that because its income-producing activities associated with its subscription revenues occurred out-of-state, none of its receipts from providing television programming to South Carolina customers were included in the South Carolina sales factor. The taxpayer originally filed its returns sourcing 100 percent of its receipts from South Carolina subscribers to South Carolina. Following an audit—where the Department did not adjust the taxpayer’s sourcing methodology—the taxpayer filed amended returns for the tax years at issue removing the receipts from South Carolina subscribers. The amended returns included a statement that the originally-filed returns incorrectly utilized market-based sourcing, rather than the costs-of-performance method prescribed by statute. The taxpayer subsequently filed its next three years of returns applying the costs-of-performance method used on its amended returns. The Department disputed this treatment and the matter went before the Administrative Law Court.
Before the court, the taxpayer bore the burden of proving by a preponderance of the evidence that the Department’s determination was wrong. For the tax years at issue, service providers were required to source their gross receipts to South Carolina if the entire income producing activity occurred in the state. If the income-producing activity occurred both within and without South Carolina then receipts were apportioned to South Carolina to the extent that the income-producing activity occurred in the state. The first issue before the court was to identify the taxpayer’s income-producing activities. The Department argued that the only income-producing activity associated with the taxpayer’s South Carolina receipts was the delivery of the taxpayer’s signals into subscribers’ homes and onto their televisions screens. The taxpayer, however, asserted that it had at least four different “value drivers” that were in essence income-producing activities. The court concluded that the taxpayer’s subscription receipts were received as a result of it delivering signals and content into customers’ homes. Therefore, the delivery of such signals was its primary income producing activity. The court declined, however to accept the Department’s position that the delivery of a signal into a customer’s home was the taxpayer’s only income-producing activity. Rather, the court concluded that the taxpayer’s evidence was “too nebulous” to properly identify whether its four value drivers were in fact producing income. The court also concluded that certain of the taxpayer’s activities appeared to be incidental to the primary income-producing activity in South Carolina. For instance, the taxpayer’s activities associated with national programming would have occurred regardless of whether there were any South Carolina subscribers. Although the court had already determined that the taxpayer failed to identify any out-of-state income-producing activities, the court nevertheless went through a lengthy discussion addressing why the taxpayer’s proposed payroll and assets sourcing methodology was, in its view, unacceptable. Finally, the court upheld the imposition of substantial underpayment penalties. Please contact Mike Raley at 704-371- 8160 with questions on DIRECTV, Inc. v. South Carolina Dep’t of Revenue.
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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.
The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.