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Tuesday, March 27, 2007

Peters & Miller on Apportionability in State Income Taxation

Tax_lawyer_2James H. Peters (Adjunct Professor, NYU Law School & Pace Business School) & Benjamin F. Miller (Counsel, Multistate Tax Affairs, California Franchise Tax Board) have published Apportionability in State Income Taxation: The Uniform Division of Income for Tax Purposes Act and Allied-Signal, 60 Tax Law. 57 (2006).  Here is the Introduction:

In 1954 the National Conference of Commissioners on Uniform State Laws, at the request of the Section of Taxation of the American Bar Association, created a special committee to draft a uniform income tax apportionment act. The result was the Uniform Division of Income for Tax Purposes Act (UDITPA). With respect to interstate taxpayers (other than financial organizations, public utilities, and individuals rendering personal services), it provides for formula apportionment of “business income” and allocation to situs of “nonbusiness income.” It defines “business income” as “income arising from transactions and activity in the regular course of the taxpayer’s trade or business and includes income from tangible and intangible property if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer’s regular trade or business operations.” All other income is classified as “nonbusiness income.”

To the extent that rents, capital gains, interest, dividends, and royalties constitute business income, they are subject to formula apportionment. Much of the controversy surrounding the interpretation of UDITPA concerns the treatment of income from property (as distinguished from manufacturing, processing, or selling) as business income. At the center of the debate is the meaning of the phrase: “if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer’s regular trade or business operations.” The differing interpretations placed on the phrase are most clearly illustrated in the treatment of capital gain or loss from the sale of business assets.

In Allied Signal, Inc. v. Director, Division of Taxation, the Supreme Court held that a state lacked the power to tax gain realized by a nondomiciliary corporation from the sale of its minority interest in another corporation. The Court firmly declared that the existence of a unitary relation between payee and payor is not the only justification for apportioning income from an investment. “What is required instead,” said the Court, “is that the capital transaction serve an operational rather than an investment function.” In regard to the definitions of business income and nonbusiness income in UDITPA, the Court acknowledged that “[i]n the abstract, these definitions may be quite compatible with the unitary business principle.”

This Article traces the history of the unitary business principle, the pre-UDITPA efforts to legislate a solution to the diverse treatment of income from interstate businesses, the origin of the business income definition in UDITPA, and its administration and judicial interpretation. It argues that the definition, properly understood, is a unitary test that is similar to the Supreme Court’s operational function test of apportionability in Allied-Signal. Throughout, California is used as the illustrative paradigm because its legislative, administrative, and decisional experience with apportionment is richer and more detailed than that of any other state.

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