Mar 28, 2016
From KPMG TaxWatch
On March 23, 2016, the Tennessee Supreme Court affirmed a decision holding that a taxpayer was required to source its receipts to Tennessee using an alternative apportionment methodology. The taxpayer, a cell phone service provider, filed its original Tennessee returns using a “primary place of use” methodology. Under this method, the taxpayer included sales billed to customers with Tennessee addresses in the sales factor numerator. Later, the taxpayer took the position that it was not “doing business” in Tennessee during the tax years at issue. Later in the litigation, the taxpayer argued that it filed its original returns utilizing an erroneous sourcing methodology, and therefore, even if it was “doing business” in Tennessee, it was entitled to a refund of franchise and excise taxes paid. Specifically, the taxpayer took the position its Tennessee receipts should be sourced using a cost of performance (COP) methodology, rather than the PPU method. While the suit over these issues was pending, the Commissioner informed the taxpayer that he was invoking his authority to require the taxpayer to source its receipts to Tennessee using an alternative method. The Commissioner’s required variance corresponded to the methodology used on the taxpayer’s originally-filed returns. After a trial court ruled for the Commissioner on the doing business issue and held that the Commissioner met his burden of proving that a variance was required to fairly represent the taxpayer’s income attributed to Tennessee, the taxpayer appealed. The appeals court concluded that the Commissioner exercised reasonable discretion when he determined that the facts and circumstances justified departure from the statutory apportionment methodology. The taxpayer subsequently appealed.
Under Tennessee law in effect for the tax years at issue, receipts from sales other than sales of tangible personal property were sourced to Tennessee if a greater proportion of the earnings-producing activity was performed in Tennessee than in any other state, based on costs of performance. Taxpayers may request, or the department may require, the use of an alternative apportionment methodology—known as a seeking or issuing a variance in Tennessee—if the standard allocation and apportionment provisions do not fairly represent the extent of the taxpayer’s business activity or net-earnings in the state. Tennessee regulations further provide that a variance may be invoked only in limited and specific cases where unusual fact situations (which ordinarily will be unique and nonrecurring) produce incongruous results.
In its opinion, the Tennessee Supreme Court first held that the lower courts did not err when they held that the Commissioner had ample basis for his conclusion that application of the statutory formula did not fairly represent the taxpayer’s business activity in Tennessee. The use of the COP method for apportionment reduced the taxpayer’s sales factor by 89 percent and allowed billions of dollars of revenue from Tennessee customers to become “invisible” for tax purposes. The court rejected the taxpayer’s argument that upholding the variance would allow the Commissioner to usurp the legislature’s authority to make tax policy choices. Rather, the legislative history behind the variance statute, which had been expanded over time to give the Commissioner more authority to invoke a variance, indicated that it was designed to alleviate the legislature’s concern about shifting income and profits.
Next, the court held that the Commissioner’s chosen variance was reasonable. Noting that no method is perfect, the court determined that sourcing the taxpayer’s receipts according to the billing address of its customers appeared reasonably suited to producing a rough approximation of the corporate income that was related to the activities conducted within Tennessee. Finally, the court addressed the variance regulation and the taxpayer’s argument that the regulation allowed the Commissioner to impose a variance only in limited and specific cases where unusual fact situations produced incongruous results. The court concluded that the fact that the application of the statutory formula would cause millions of dollars of receipts from Tennessee customers to “vanish” for tax purposes created an “unusual fact pattern.” Furthermore, the subject variance was applied in a “limited and specific case” as the taxpayer presented no evidence that other telecommunications companies had been subject to the same variance. Next, the court observed that although the regulation contemplates that variances will ordinarily be applied in unique and nonrecurring situations, the use of the term “ordinarily” means that the unique and nonrecurring language is not a hard and fast rule. Finally, the court concluded that the variance at issue was not outside of the range of acceptable alternatives available to the Commissioner and did not constitute an abuse of the Commissioner‘s discretion. For more information on Vodafone Americas Holdings Inc. v. Roberts, please contact Blair Norman at 615-248-5544.
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