United States

Oregon: State Supreme Court Approves of Transactional Approach to the Income-Producing Activity Test

Sep 21, 2015
From KPMG TaxWatch

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Recently, the Oregon Supreme Court affirmed a 2011 tax court decision addressing the application of the income-producing activity test used to source receipts from sales of other than tangible personal property. Under Oregon law, gross receipts from sales of other than tangible personal property are considered Oregon gross receipts if (a) the income-producing activity is performed in Oregon or (b) the income-producing activity is performed both inside and outside of Oregon and a greater proportion of the income-producing activity is performed in Oregon than in any other state, based on costs of performance. The taxpayer, a global telecommunications service provider, filed amended returns excluding certain receipts from calls that originated or terminated in Oregon from the numerator of the Oregon receipts factor.  In the taxpayer’s view, because the greater costs of performance associated with its income-producing activities occurred at its New Jersey global operations center, none of these receipts should have been included in the Oregon sales factor numerator. The Department disagreed and the matter went before the Tax Court. The court, adopting a so-called transactional approach to applying the income producing activity test, held that the costs of performance analysis applied narrowly to each transaction and that only direct costs incurred for a given phone call or transmission should be considered in determining costs of performance. The taxpayer subsequently appealed.

The Oregon Supreme Court observed that the outcome of the case depended on the precise meaning of the terms “income-producing activity” and “costs of performance.”  The Department argued that the definition of “income-producing activity” was transaction focused and the term was intended to apply to each individual call or separate monthly billing. The taxpayer, on the other hand, argued that the term captured its network and system-wide costs. Because the statute was not clear on this point, the court looked to the Department’s regulation to determine the meaning of these terms.  Per the regulation, the income producing activity applied to each item of income and required a taxpayer to determine the relevant transactions and activity associated with each call or transmission. Therefore, in the court’s view, any ambiguity in the statutory text was eliminated in the rule.  After determining the scope of the income producing activity test, the court considered what costs were “direct costs” included in measuring the costs of performance associated with the income producing activities (i.e... those costs associated with each individual transmission or call). A cost study submitted by the taxpayer treated its overall network costs as direct costs. However, because the income producing activity test applied only to individual transactions “direct costs” could only be costs associated with each transaction. Network costs therefore would be excluded. Because the taxpayer’s cost study did not correctly identify its costs of performance, the court affirmed the denial of the taxpayer’s refund claims. For more information on AT&T Corp.v. Dep’t of Revenue, please contact Rob Passmore at 503-820-6844. 

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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.