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State and Local Taxation Hellerstein Fall 2011


Chapter 1 1. a. INTRODUCTION Basic Info 1. Sales and Use Tax a. USE TAX 1. Tax on storage, use or other consumption in the sate of tangible personal property. 2. Assessed upon tax free personal property purchased by a resident of the assessing state for use, storage, or consumption of goods in that state regardless of where the purchase too place. 3. The use tax is typically assessed at the same rate as the sales tax that would have been owed (if any) had the same goods been purchased in the state of residence. Typical "tax free" purchases that require payment of use tax include those done while traveling (for things carried or sent home), through mail order, or purchases via telephone or internet. 4. HYPO: A car. Once you get back to the state, first thing you must do is register it. If you tell them that you paid a sales tax, they credit you for the sales tax up to the amount you would have paid in sales tax in the state of domicile. a. However, it is these registered goods that make it easy for the state to collect. If there is no registration requirement it is VERY hard to put the onus on the state to collect these taxes. b. Therefore, companies like Amazon do not need to collect the tax, it can be up to the consumer to pay a use tax. 5. HYPO: if you are Wal Mart and you want to compete with Amazon what do you do? a. Create a separate entity i.e. Walmart.com, to sell the book.

Chapter 2 2. a. CHAPTER 2: JURISDICTION TO TAX Section 1: Due Process And Commerce Clause Restraints On State Taxing Jxn 1. Similar concept to jxn over person for purpose of non resident jxn, same inquiry. 2. DP: Minimum contacts, purposeful availment, and NO requirement of physical presence, fairness notion/ notice, cant offend traditional notions of fair play

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and substantial justice. Minimum connection btwn state and person/property/or trans to tax. CC: How is this analysis different from the DP analysis? The main issue is whether it is unduly burdensome to interstate commerce. Is it burdensome to require out of state vendor to collect tax (i.e. in Quill). Must have substantial nexus a. It could be extremely burdensome, because all sorts of small vendors would have many tax laws to sift through in order to sell goods in another state. Quill Corporation v. ND ISSUE: When is there jxnal power in a state to require a non resident or a physically absent vendor to do what a present vendor does: Collect taxes? a. The problem is there is no jurisdiction over the vendor to collect the tax how can the state enforce the use tax? Held a. The mail order business did not need to have physical presence in state in order to permit state to require business to collect use tax from its in state customers, BUT b. Physical presence in state was required for business to have substantial nexus with taxing state, as per commerce clause. Mere economic exploitation will not satisfy The Due Process Clause requires some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax, and that the income attributed to the state for tax purposes must be rationally related to values connected with the taxing State. a. relevant inquiry is whether defendant has minimum contacts with the jurisdiction such that the maintenance of the suit does not offend traditional notions of fair play and substantial justice. In that spirit, the more formalistic tests that focused on a defendant's "presence" within a state are set aside in favor of a more flexible inquiry into whether a defendant's contacts with the forum make it reasonable, in the context of our federal system of government, to require it to defend the suit in that state. All assertions of statecourt jurisdiction must be evaluated according to the standards set forth in International Shoe and its progeny. Ct bifurcates DP and CC analysis and says physical presence test with regards to CC in sales/ use tax area. Here there might have been DP rationale, but no CC rationale to tax. a. Due Process Argument that there were insufficient minimum contacts between the out of state vendor and taxing state to allow the state to impose the obligation on the nonresident vendor. 1. The court said that the due process clause does not bar taxation because THERE ARE CONTACTS. There is purposeful availment. 2. Minimum contacts do NOT necessarily mean physical contacts. All there needs to be are directed activities towards the state. The validity of the tax here is related to the benefit receives from access to the state. 3. Has state provided some protection, opportunities, or benefit for which it can expect a return b. Commerce Clause v. Due Process

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Due Process: Based on fairness, and in this case it would not be unfair to call them into court. 2. Commerce Clause: based on not burdening interstate commerce. 3. The court equates the burden on commerce to whether or not there is a physical presence. 4. Fn 8 a few floppy diskettes to which Quill holds title seems a slender thread upon which to base nexus. Not enough 5. Under Complete Autos four part test, will sustain a tax against a CC challenge so as 6. tax is applied to an activity with a substantial nexus with the taxing state (not same as DP, physical presence the line btwn jurisdiction and no jurisdiction) narrower than DP 7. tax is fairly apportioned 8. tax does not discriminate against interstate commerce 9. tax is fairly related to the services provided by the state. **NOTE** Congress can change the rule of Quill a. Congress cannot authorize violation of the 4th amendment, but the basis of the commerce clause could be reversed with just a swipe of the pen by Congress 1. Whenever the US SC hands down a decision under the commerce clause, it is really a decision written in the absence of Congressional Consent. HYPO a. What about DELL, where they send someone into your home, that is an independent contractor, to fix your computer? 1. They are collecting the tax that may be due on the warranty, and will remit a tax on behalf of the independent contractor. But will not collect a tax on the sale of the CPU not in state. Tyler Pipe and Scripto, pg 368 The presence of an out of state taxpayers rep in the state COULD provide a constitutional basis for nexus and that it was not constitutionally significant whether such a rep was denominated an employee or an independent contractor. It is easy to see jxn when agent or principal present this goes one step further and says jxn when third party is present. Other situations a. Subsidiary having a sub in a state does NOT give jxn over parent company and vice-versa b. Mail order generally cts have said not enough presence to collect tax c. Wal Mart Situation similar to the Borders situation, California court said the retail store is a rep of the mail order portion and therefore subject to tax under these cases. Physical Presence standard and E-Commerce To the extent online retailers can avoid establishing physical presence in the states where products are consumed, Quill prohibits those states from imposing a use tax collection obligaiton. Amazon v. NY

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3. Amazon had referral online system, paid commissions to other websites who directed
traffic that led to purchases. Amazon argue it is advertising v. commissions

4. Only at NY trial court level currently, (look up appeallate level) 5. Substantial nexus - physical presence of vendor is required, however it need not be
substantial. Must be demonstrably more than a slightest presence. May be manifested by economic activities in the taxing state performed by vendor's personnel or its behalf. Can be imputed based on in-state solicitation of sales by employee, agent, independent contractor. 6. Contrast with Quill, if only connection with state is solicitation from out of state through catalogs, flyers, and delivery of merchandise to customers through mail, insufficient nexus for taxation. 7. So as long as nexus, taxes that must be collected need not derive from seller's in-state activity. Section 2: Jurisdiction to Tax Income Generally One cannot assume that Quills bright line, physical present analysis will necessarily apply to other taxes. Nexus or jxn to tax often involves two separate inquiries, even though they may not be separately explicated 1. Is there jxn over the taxpayer 2. Is jxn over the transaction, activity, or event or the income, or property. c. As a practical matter 1. If only dealing with DP looking to see if activities directed towards state. d. Cases (1) WV v. MBNA 9. Bank's only contact with state was through mail and phone solicitation regularly 10. Physical presence is not necessary in order to show a substantial nexus for purposes of state taxation of forgein corporations. 11. Same standard as due process. Sales and use has higher requirement b/c of stare decisis. Substantial reliance on that decision. Benefits of bright line rule. Applying to sales and use taxes is undue burden on interstate commerce. Not so for income. Lesser compliance burdens. Physical presence poor measuring stick of an entity's true nexus with a state in today's business world. 12. Significant economic presence test - test used to determine of whether a substantial nexus exists for CC purposes. Incorporates due process purposeful direction towards a state while examining the degree to which a company has exploited a local market. Purposeful availment is analyzed as it is for DP. CC requires additional examination of frequency, quantity, and systematic nature of a taxpayer's economic contacts with a state. 13. Residence v. source. Can be taxed by either jurisdiction. If conflict, usually source jurisdiciton yields 14. JC Penney v. Johnson, pg 370 (not in book) (not good law I believe) a. Facts 1. They were incorporated in Delaware, no presence in Tenn, consumer solicited via email.

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All income tax was paid in Del. Tenn assessed franchise and excise taxes. 3. Appellant bank appealed the decision upholding the imposition of franchise and excise taxes on income generated by credit card activities in the state 4. Court reversed finding that while appellants relationship with the state satisfied due process minimum contacts, it did not satisfy the substantial nexus needed for CC. 5. Dormant CC serves to prohibit state actions that interfere w/ IC, fact that CC grants congress specific pwr to reg IC carries negative implication that the states may NOT act to interfere w/ IC, substantial nexus under CC NOT same as min contacts under DP 6. CC requires greater relation than DP b. Merely doing business in the state was no sufficient (there were no agents in Tenn) some physical presence required. Presence of tangible credit cards is not enough for finding substantial nexus, nor did the presence of retail stores that were wholly unrelated to the credit card business 1. Mail not substantial nexus for CC. c. This case suggests that physical presence test seems to apply to income taxes, BUT, court steps back in later case where AOL presence was not that different from JC Penney court sent it back for further factual investigation suggesting that not yet determined that physical presence required for CC cases. d. Potential result: virtual bank, now can create credit card activity where you are NOT physical present AND can contract out to 3rd parties all sorts of physical functions, independent contractor NOT necessary create tax obligation for person who K with that person. e. One positive of this case it creates a brightline rule. 15. Geoffrey v. South Carolina Tax Commissioner a. The presence of intangible property alone is sufficient to exstablish nexus for CC analysis. b. Facts 1. Toy R Us transferred their trademark to the subsidiary, which then licensed them back to the brick and mortar stores. 2. Appellant foreign corporation received royalty payments based upon sales made in SC from a licensee that did business in SC. 3. SC required appellant ot pay income tax on the royalty income, and a corporate license fee. 4. The parent entity licensed the intangible property to the store entity. c. Held 1. There were minimum contacts that were required by DP because it licensed intangibles for use in the state and received income in exchange for their use, and had intangible property in the state. 2. Also permissible under CC. 3. The physical presence test did NOT apply to income taxes because there was only an intangible presence in SC. d. How was Geoffrey tax calculated? 3 factors 1. Start with Federal Income tax (not just income in the state)

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((prop in SC/ total prop) + (sales in SC/ Total Sales) + (payroll in SC/ Total payroll)/3) 3. This gives a % that is multiplied by fed taxable income to determime SC income 4. They created this type of deal, because gross receipts would be reduced by the amount of royalties paid to the subsidiary out of state. In Delaware you are not taxed if all you do is manage intangibles. e. South Carolina Strategy: Go after Geoffrey directly and say have jxn over them on the notion that dont need physical presence in state to have income there. 1. Also could have said: 2. Any entity essentially engaged in same business combined 3. Geoffrey was a sham 4. Royalty rate was excessive 16. Inconsistencies 17. JC Penney v. Geoffrey Does the physical presence requirement apply to income taxes? a. Quill leaves open the Question of whether physical presence test applies outside of sales and use context. The answer is unclear. 1. There was a split can either go in the direction of Quill that it is NOT limited to sales and use tax and not have different CC rule for different types of taxes, but then must deal with the counter argument that Quill was narrowly decided, based heavily on Stare Decisis, and court suggests that physical presence may not be required. 18. JC Penney/Geoffrey v. Quill a. Policy arguments implicit in Quill should we have 1 type of rule in income tax area and not in sales and use area? b. Quill concerned with thousands of jurisdictions that all had different tax rates for sales and use difficult for mom and pop stores to comply. 1. Not as serious for income tax only 50 jxns. (there are some sub state entities that tax). 2. With sales and use administration is a problem because of the sheer number of transactions, but income is only once a year. 3. Focus on enforcement there is usually a higher standard for income vs. consumption and substantive tax obligations. 19. Other Sources 20. Corporate Excise DOR Directive 96-2 (Mass) a. A foreign corporations intangible property used within Mass will subject that corp to the corporate excise when (essentially an economic nexus) 1. The intangible prop generates or is otherwise a source of gross receipts within the state for the corp, including through a license or franchise; and 2. The activity through which the corp obtains such gross receipts from its intangible property is purposeful (i.e. a contract with an instate company); and 3. The corporations presence within the state as indicated by its intangible property and its activities with respect to that property is more than de minimis. 21. Section 3: Public Law 86-272: Congressional Action Restricting The Power of State Taxation of Interstate Business, pg 402

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Background Principal effect is to deny the states the power to impose taxes on or measured by net income derived within the state from interstate commerce if the only bizz activity carried on within the state are the solicitation of orders for sales of tangible personal property, where the orders are sent outside the state for approval or rejection and are filled byshipment or delivery from a point outside the state. For the most parts we are dealing with federal constitutional restraints There is one law it is the only really broad legislation. It is an important jxnal limitation on what states can do Northwestern Case (not in book) Served as the spurring force for this law. Sustained the states power to impose a nondiscriminatory, fairly apportioned direct net income tax on an exclusively interstate business. Public Law 86-272 Congressional Action Restricting the power of state taxation of interstate business Statute 1. 101(a) NO state has the power to impose a net income tax on income derived within such state by any person from INTERSTATE COMMERCE if the only business activities within such state by or on behalf of such person are either OR both: a. Solicitation of orders by such person, or his rep, in such state for sales of tangible personal property, which orders are sent outside the state for approval or rejection and if approved are filled by shipment or delivery from a point outside the state AND b. [wholesalers] solicitation of order by such person/ representative in such state in the name of or for the benefit of a prospective customer of such person, if orders by such customer to such person to enable customer to fill orders resulting from solicitation are orders described above. 2. 101(b) Provisions of (a) DO NOT APPLY to the imposition of a net income tax by any state with respect to a. Corporation incorporated under that states laws b. Individuals domiciled in that state or a resident of that state c. [Independent Contractors] For the purposes of 101(a), a person shall NOT be considered to have engaged in business activities merely because of sales in such state, OR the solicitation of orders for sales in such state, of tangible personal property on behalf of such person by one or more independent contractors, or by reason of the maintenance of an office in such state by one or more independent contractors whose activities on behalf of such person in such state consist solely of making sales, or soliciting orders for sales of tangible personal property. Two categories of Solicitation Protected 1. Direct orders from purchaser by seller 2. Indirect for benefit of prospective customer 3. Upshot: a. Pt of origin test for shipment made from outside state b. ALSO, de minimis exception for activities that go beyond trivial The legislation is carefully circumscribed and is limited to:

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Selling tangible personal property Solicitation and related activities a. There is no immunity granted for collecting some of the purchase price in state. 3. Local warehousing a. Local warehousing and delivery of goods out of a local warehouse CLEARLY lie beyond the pale of the minimum standards established for immunity b. Shipment must be made from a point outside the state. c. Some states have taken the position that delivery by the vendors trucks deprives the vendor of immunity. 4. Sales office a. Maintenance of a sales office within the state designed to serve local solicitors takes the taxpayer OUTSIDE the area of immunity. 5. Domestic corporations a. Law does not seek to restrict the states powers to tax either domestic corporations or individuals domiciled in the state 6. Net income taxes a. The law applies only to net income taxes, which include any tax imposed on, or measured by net income. b. The law does not apply to the general business taxes of states that do not employ a net income measure. c. in those states only limitations on the states jxn to tax are those attributable to Constitutional restraints. Independent sales representative 1. Immunity statutes extends to the use of sales reps i.e. independent contractors. 2. Must represent MORE than one principal and hold themselves out as such sales rep. 3. Independent broker MAY COMPLETE SALES IN STATE, and may maintain an office. Wisconsin Department of Rev v. Wrigley Solicitation of orders not just explicit verbal requests for orders, but also any speech or conduct that implicitly. Not merely the ultimate activity of inviting an order but the entire process associated with the invitation. Activities that are entirely ancillary to requests for purchases, in other words those that serve no independent bizz function apart from their connection to the soliciting of orders, are permisslbe. Facts 1. Based in Chicago. The district manager had his residence in Illinois and visited Wisconsin only 6-9 days each year. 2. Regional manager resided in Wisconsin, but Wrigley did not provide him with a company office 3. Sales representatives would fill racks, replace stale gum etc. a. Provided free sales racks to stores 4. All orders were sent to Chicago. 5. Wrigley did not own or lease real property in Wisconsin a. Did not have a telephone listing or bank account.

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Credit collection and activities were similarly handled by the Chicago office. c. All advertising in Wisconsin was handled by an independent Chicago advert agency. q. The court was of the opinion that the term solicitation in the statute included not just explicit verbal requests for orders but also any speech or conduct that implicitly invited order (those actions that serve no independent business function apart from their connection to solicitation of orders). 1. Nevertheless, the court concluded that the additional actions (replacing gum, supplying agency checks for forwards on inventory) and gum storage by sales rep were not ancillary. a. Because the activities served an independent business function quite separate from requesting orders, it was not immune. r. Notes After the Case 1. The Scope of Solicitation of Orders a. Activities that are entirely ancillary to requests for purchases, in other words those that serve no independent business function apart from their connection to the soliciting of orders, are permissible and therefore nontaxable. b. Those activities that the company would have had reason to engage in anyway but chose to allocate to its in state sales force are not protected. 2. De Minimis Activities that go Beyond the Scope of Mere Solicitation a. The court carved out an exception for those de minimis activities that despite being beyond the scope of solicitation of orders, constitute trivial connections with the taxing state. 3. Income Tax Immunity of In-State Reps Soliciting Orders Falling within Scope of 86-272 for Out of State Sellers a. It is clear that an out of state that an out of state seller that directly, or through an in state rep, does no more than solicit orders described in 86-272 enjoys immunity from state income tax in the state of solicitation b. It is less clear whether a leally separate in state rep whose sole activity is the solicitation of orders described in 86-272 enjoys immunity from state income tax. c. some state have taken the position that a manufacturers rep that solicits orders for an out of state company IS subject to tax on its income, because it derives income from the sale of marketing services rather than from the sale of tangible personal property. 4. Does Qualifying to Do Business in a State Remove a Corp from Protection? a. Almost every court that has considered if mere qualification to do business removes immunity has held that it does not. b. Conn: 86-272 expressly permits a state to impose a net income tax on corp taxpayer whose only in state activities are the solicitation of orders if such taxpayer are inc under the laws of the state c. taxing mere qualification becomes a non sequitur. Section 4: What Constitutes Doing Business Under the State Taxing Statutes?

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The Different Functions of the Doing Business Concept The term doing business is used in state statutes in three distinct situations 1. Statutes that require foreign corps to qualify in order to transact local business 2. Statutes directed to the amenability of the foreign corp to suit and service of process 3. Statues imposing excise taxes upon foreign corps for the priv of doing local business. Doing Business: The Basic Concepts Rely on such factors as 1. Maintaining an office in state 2. Employing capital in the state 3. Owning or leasing property in the state 4. Simply engaging in any activity for profit in the state. Doing Business Through Agents and Independent Contractors Solicitation by an independent contractor does NOT oridinarily subject the seller to franchise taxes. If a seller carries on local solicitation, advertising, or promotion through its agents, however, courts ordinarily will find that the seller is subject to tax

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Due Process Clause. Nexus Distinction from Commerce Clause Nexus. Quill Corp (US 92). A corporation may have the minimum contacts' with a taxing State as required by the Due Process Clause, and yet lack the substantial nexus' with the State as required by the Commerce Clause, which occurred in Quill. 1. Due Process. Requires some definite link, some minimum connection, between a state and the person, property, or transaction it seeks to tax; and 2) that the income attributed to the state for tax purposes must be rationally related to value connected with the taxing state. a. First prong: If a foreign corporation purposefully avails itself of the benefits of an economic market in the forum State, it may subject itself to the State's in personam jurisdiction even if it has no physical presence in the State. As long as an out-of-state mail-order vendor purposefully directs its solicitation toward residents of the taxing state, it matters little that such solicitation is accomplished by a deluge of catalogs rather than a phalanx of drummers: the requirements of due process are met irrespective of a corporation's lack of physical presence in the taxing State. 1. Hence, could happen that TP is present inadvertently and hence, cannot be taxed under Due Process Clause 2. Commerce Clause: at least in the context of use tax collection obligations, the physical-presence test articulated twenty-five years earlier in National Bellas Hess, Inc. remained the Commerce Clause substantial nexus standard. a. Rationale: The Court defended the bright-line rule of Bellas Hess on the ground that it firmly establishes the boundaries of legitimate state authority, reduces litigation, encourages settled expectations, and serves

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the interest in stability and orderly development of the law that undergirds the doctrine of stare decisis

Chapter 3 24. a. CHAPTER 3: COMMERCE CLAUSE RESTRICTIONS ON STATE AND LOCAL TAXATION Background 1. Fundamental Question is whether something affects commerce. 2. CC is an affirmative grant of power to Congress to regulate to regulate commerce. a. The court accepts the notion that also negatively limits what states can do, i.e the dormant commerce clause. b. Congress only has the power to limit those actions that involve interstate commerce so while there are some limits, practically speaking, those limits are very limited. 3. Historical Review 4. Northwestern Case: 1st time the court decided that state could impose net income tax that fairly apportioned, non discriminatory. There was a three factor formula based on in in state activity, property, payroll, nexus. 5. Pub Law 86-272 passed as a result no tax if interstate business selling did not exceed the threshold 6. Complete Auto: said distinctions in past NOT responsive to what view as key criteria to determine if tax burdens commerce said the 4 questions just get rid of legal clutter, and recognition that move away from formalization. Section 3: Taxes Imposed on the Privilege of Doing Business in the State 1. Complete Auto Transit v. Brady a. Court embraced a view of the state's taxing powers that makes irrelevant the classification of a tax as a direct, as dintinguised from an indirect levy on interstate commerce. (1) activity with a substantial nexus with the taxing state (2) is fairly apportioned (3) does not discriminate against interstate commerce (4) and is fairly related to the services provided by the state. Facts a. Hauling cars from Michigan to Mississippi, just interstate transport, was assessed back taxes for the sales of transportation services. b. Taxes were imposed under the guise of privilege of doing business within the state. c. Corporation said this flew in the face of the CC. 3. Held

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The tax imposed by the state upon the corporation engaged in interstate commerce for the privilege of doing business was NOT unconstitutional 4. This case articulates that test which had been around. a. Substantial Nexus 1. Need connection with the state b. Fair Apportionment tax base limited to reflect ONLY the activities of the taxpayer in the taxing state 1. The slice of the apportionable pie that the state can tax here is mileagely proportional. c. Discrimination against Interstate Commerce 1. Court cannot tolerate ANY kind of discrimination (no concept of de minimis discrimination) 2. Here there was no discrimination because the tax applied regardless of where the truck came from. d. Fair Relation to services provided by state (Commonwealth v. Edison). 5. Functional Effect of this Case a. Overruled Spector Motor Service which has held that a state tax on the privilege of doing business was PER SE unconstitutional when it was applied to interstate commerce. b. Under Spector, states could wordsmith their way around the traditional rule 1. Colonial Pipeline, pg 234 a tax was struck don on interstate business principles, then was reworded to be a tax on the corporate form, and it was sustained. c. Prong 1: substantial nexus 1. Tyler Pipe 2. Crucial factor governing nexus is whether the activities performed in this state on behalf of the taxpayer are significantly associated with the taxpayer's ability to establish and maintain a market in this state for the sales. 3. Employees v. independent contractor doesnt matter Prong 2: fair apportioned to the taxpayer's activities carried on in the taxing state. 1. Norfolk and western v. Missouri 2. Any formula used must bear a rational relationship, both on its face and in its application, to property values connected with the taxing state. "gross overreaching" must be shown. State assessed property at 4 times what actually was in state (rolling stock) 3. Not necessary that a state demonstrate that its use of the mileage formula has resulted in an exact measure of value. But when a taxpayer comes forward with strong evidence tending to prove that the mileage formula will yield a grossly distorted result in its particular case, state is obliged to change its assessed tax. 4. Must be internally and externally consistent. To be internally - tax must be structured so that if every state were to impose an identical tax, no multiple taxation would result. Externally - has state taxed only that portion of the revenues from the interstate activity which reasonably reflects the in-state component of the activity being taxed.

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Prong 3: Nondiscrimination of interstate commerce Camps newfound v. Harrison Disadvantaged camp that had predominately out of state consumers. Prevented it from receiving property tax exemption. Given the court's broad view of the scope of the dormant commerce clause, it will be rare case in which any serious claim can be made that a tax is immune from scrutiny under substantive CC standards on the ground that the tax does not substantially affect interstate commerce. Internal consistency? Exception: Complementary taxes - specific way of justifying a facially discriminatory tax as achieving a legitimate local purpose that cannot be achieved through nondiscriminatory means. Tax that imposes on interstate commerce the rough equivalent of an identifiable and substantially similar tax on intrastate commerce does not offend the negative CC. Cuno v. Daimlerchrysler NEED BETTER ANLYSIS Discrimination simply means differential treatment of in-state and outof-state economic interests that benefits the former an burdens the latter. Direct subsidization of domestic industry does not ordinarily run afoul of the CC. Distinction btwn a subsidy and a tax credit results from the fact that the tax credit involves state regulation of interstate commerce through its power to tax. Must be internally consistent, if universally applied, new property would escape tax liability irrespective of location. Income tax credit struck down, b/c coercive tax incentive. Not okay if require beneficiary to engage in another form of business in order to receive the benefit or is limited to businesses with a specified economic presence. But ok if invest in new equipment, does not reduce any pre-existing income. Prong 4: fair relation to services provided by state Commonwealth edison v. Montana Not the amount of the tax or the value of the benefits allegedly bestowed as measured by the costs the state incurs on account of the taxpayers activities, rather the test is closely connected to the first prong, bizz must have a substantial nexus with the state before any tax may be levied on it. Also imposes additional limitation that the measure of the tax must be reasonably related to the extent of the contact, since it is the activies that may properly be made to bear a just share of state tax burden. When a tax is assessed in proportion to a taxpayers activities in a state, the taxpayer is shouldering its fair share of supporting the states provisions. Reasonably related to the taxpayers actiives or presence from which is derives some subsantial benefit. Here tax on amount of coal mined. Purpose of test is to ensure that a state's tax burden is not placed upon persons who do not benefits from services provided by state. Section 6: Taxation of Instrumentalities of Interstate Commerce, pg 247 Goldberg v. Sweet, pg 247 Facts There was a tax on phone calls that originated/ terminated in Illinois, and were charged to Illinois service address. There was a credit if it was paid in other state. Residents filed a class action complaint claiming a violation of CC.

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Held Tax was Alright Complete Auto factor analysis Nexus there is no nexus issue here. Everyone conceded that. i. When we think about nexus we need to ask if there is nexus with the person and is there nexus with the transaction. Fair Apportionment At first glance this looks to be unfairly apportioned. i. In CAT they were only taxing the mileage in the state. ii. However, in this case the court determined fair apportionment by determining if the case was internally and externally consistent iii. Internally Consistent: If every state were to implement this type of tax, there would be no double tax. If every state imposed the same tax would it be double tax? iv. Externally Consistent: reasonably reflecting the in state activity of the retail purchase of telecommunications, not susceptible to an easy mileage breakdown Discriminate Against Interstate Commerce The tax avoids this result. i. The discrimination argument example: ii. A call originating and terminating in Illinois that costs $ 10 is taxed at full value at 5%. A second call, originating in Illinois but terminating in Indiana, costs the same $ 10 and is taxed at the same full value at the same 5% rate. But while Illinois may properly tax the entire $ 10 of the first call, it (technically) may tax only that portion of the second call over which it has jurisdiction, namely, the intrastate portion of the call (say, for example, $ 5). By imposing an identical 50 cents tax on the two calls, Illinois has imposed a disproportionate economic burden on the interstate call. See American Trucking Assns., Inc. v. Scheiner, 483 U.S. 266 (1987) (invalidating flat tax that imposed disproportionate economic burden on interstate commerce).

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This argument, however, overlooks the true overall incidence of the Illinois tax. Although Illinois taxes the entirety of every call charged to an Illinois number, it does not tax any part of the calls that are received at an Illinois number but charged elsewhere. Thus, although Illinois taxes the entire Illinois-Indiana $ 10 call, it taxes no part of the reciprocal IndianaIllinois $ 10 call. At the 5% rate, Illinois receives 50 cents from the two calls combined, precisely the amount it receives from one $ 10 purely intrastate call. By taxing half of the relevant universe of interstate calls at full value, Illinois achieves the same economic result as taxing all of those calls at half value would achieve. As a result, interstate phone calls are taxed at a lower effective rate than intrastate calls, and accordingly bear a proportional tax burden. Fairly Related. Section 7: Levies Discriminating Against Interstate Commerce a. Haliburton Oil Well v. Reilly Facts

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Taxpayer was an oil well servicer. Its business required the use of specialized equipment which was not readily available on the open market. ii. Equipment manufactured in Oklahoma and shipped to La. iii. In state tax returns, taxpayer did not include the value of labor and shop overhead attributable to assembling the equipment. Essentially this is a use tax case, where the claim is discrimination. This was a case where the state conceded that because what was bought was done out of state, there was a use tax that would not have been applied had the equipment been bought in the state. Held i. the proper comparisons were between equipment assembled in Louisiana and equipment assembled out of state, and between isolated sales made in Louisiana and isolated sales made out of state, and by these comparisons the Louisiana use tax as applied in the case at bar was shown to be invalid as discriminating against interstate commerce in violation of the commerce clause, because equal treatment for in-state and out-ofstate taxpayers similarly situated is the condition precedent for a valid use tax on goods imported from out of state Internal Consistency interstate companies treated the same as intrastate companies Notes i. Discriminatory Transfer of Stock Sold on Out of State Exchange ii. Boston Stock Exchange v. State Tax Commissioner, pg 271 a. The court considered a NY stock transfer tax scheme that provided reduced rates for certain transfers of stock through the NY transfer agent when the sale of the stock was effected through the NYSE b. The court struck down the tax observing: the obvious effect of the tax is to extend a financial advantage to sales on the NY exchanges at the expense of the regional exchanges. Rather than compensating NY for a supposed competitive disadvantage resulting from the former statute, the amendment providing the tax break forecloses tax neutral decisions and creates both an advantage for the exchange in NY and a discriminatory burden on commerce to her sister states. iii. Differential Treatment of Transactions in Different Markets iv. General Motors v. Tracy, pg 278 a. Court confronted the question whether a sales and use tax scheme that exempted certain in state sales of natural gas while taxing out of state sales of natural gas discriminated against interstate commerce in violation of the commerce clause. b. There was a clearly discriminatory tax, where there was a use tax on natural gas purchased out of state and not purchased in state. c. Court said these were two discrete markets local only selling regulated gas, so NO competition b/w markets and NO

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discrimination. So just establishing discrimination without showing ACTUAL IMPACT will not get you relief. Cuno v. Daimler Chrysler, pg 280 Facts i. On appeal, the local businesses primary contention was that the OHIO statutes authorizing the investment tax credit and personal property tax exemption violated the commerce clause, and that the tax violated the EP clause ii. Dispute concerned whether Ohios method for encouraging new economic investment, conferring investment tax incentives and property tax exemptions, impermissibly discriminated against interstate commerce. iii. CofA concluded that the investment tax credit scheme VIOLATED the CC iv. the benefits discriminated against interstate economic activity by coercing businesses already subject to the Ohio franchise tax to expand locally rather than out of state. v. The alleged injury was that the tax breaks diminished the funds available to the city and state, imposing disproportionate burden on them Held i. It was unclear that the taxbreaks did in fact deplete the treasury ii. The taxpayers alleged injury was conjectural or hypothetical in that it depended on how legislators responded iii. The taxpayers claims were no different from similar claims by federal taxpayers already rejected iv. there was no standing to challenge certain of the taxes v. State taxpayers have no standing under U.S. Const. art. III to challenge state tax or spending decisions simply by virtue of their status as taxpayers. vi. Taxpayers commerce clause challenge was not just like an est clause challenge. **Procedural Note on bringing tax cases in federal court** unless Congress provides an exception, you cannot bring a state tax case in federal court unless you can show there is adequate remedy within the state which is almost never. i. There is a longstanding respect for state administration of their own remedies and with few exceptions you cant litigate state taxes in federal court until you get to the SC. Tax Injunction Act: Congressional action, which does not let a taxpayer bring a state tax case in federal court unless there is no adequate remedy at state law i. Respectful of federalism ii. Cuno started in state court iii. EXCEPTION to the tax in junction act iv. If the person bringing the suit prevails resulting in more money coming into the state then you can get around the tax injunction act v. Here if Cuno prevails more money could come into the state b/c these credits would not be available so they got around the tax in junction act

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Standing In state courts the state can make the standing rules that they want BUT in federal court there has to be a case in controversy ii. S.Ct. found that Cuno did not have standing iii. Cuno (the taxpayer) should vote to end corporate welfare iv. No concrete injury here, and no relief v. State of Michigan (complaining that they lost business b/c OH provided the benefit) also did not have standing vi. Kims Auto Body (whose land was taken for the plant) was already goon so they also did not have standing vii. Note: that she could bring this suit in state ct. viii. Note: also note that if the challenge had been to the property tax exemption that she would have had standing ix. Municipal tax payer does have standing to challenge municipal tax expenditures x. b/c the municipality is smaller like a corporation xi. makes sense when you think about the working of property tax system a. if you take somebody off the role then others have to pay the money to pick up the slack and keep the municipality rolling Supreme Court i. Plaintiffs' principal claim that the franchise tax credit depletes state funds to which they contribute through their taxes, and thus diminishes the total funds available for lawful uses and imposes disproportionate burdens on them, is insufficient to establish standing under Article III. Sixth Circuit (Looking at the Merits) i. Court struck down the investment tax credit on the CC, and said the property tax was legit. ii. they said that the franchise tax caused companies to expand in state, so they could expand sans tax, rather than move out of state where they would be subject to a tax. The state has a coercive grip on you. a. Essentially the difference is that you have a lot of tax liability, and you do not have to pay it, unless you leave the state, then you do have to pay it- that is why it is coercive. iii. The Property tax exemption, though, was internally consistent. If every state had that, it would not matter where you expanded to. Proposed Bill (p289) a. In the end, if Congress wants to make the rules in this area of corporate welfare, they can b/c Congress has the last word here (Thomas / Scalia point) b. Congress is authorizing the entire universe i. DCC doesnt apply to any incentives authorized by Congress 1) Except . . . (any tax incentive dependent upon state corporations) throws back up into DCC area ii. Example: if GA wanted to provide tax incentive for GA corporations, this falls w/in the exception, doesnt mean cannot have just means Congress didnt authorize it c. Everyone of the exceptions reflects a case or body of cases

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i. Longstanding body of case law that says states cannot discriminate on basis of residence 1) Goes back to WI case, where would that exemption fall after this legislation? a) No question it is a tax incentive so presumptively valid unless it falls under the exclusion & then have DCC question d. Analysis: i. Is this an incentive? Yes ii. Does it fall w/in the exception under the bill? If it does then have a DCC analysis issue

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Section 8: Severance Taxes Commonwealth Edison v. Montana, pg 290 Facts Several Montana coal producers and their pout of state utility company customers filed suits against the state of Montana seeking refunds of severance taxes paid under protest argued under Supremacy and CC c. The primary issue, of the Complete Auto factors, was the Fairly Related to Services Provided by State. d. Held The states imposition of the severance tax did not violate the commerce clause. The tax was computed at the same rate regardless of the final destination. i. It was irrelevant that most of the coal was shipped out of state shifting the burden to nonresidents/ The states imposition of the tax as applied to the mining of federally owned coal was not invalid under supremacy clause. e. The only time a tax wont be reasonably apportioned is if its a flat tax Section 11: Taxation of Foreign Commerce, pg 308 a. Background b. When tax affects foreign commerce two additional prongs Tax must not prevent federal government from speaking with one voice national policy to be sensitive to states undercutting policies and interfering with federal role International multiple taxation concerns c. Japan Line v. County of LA, pg 308 (**note this case has not been expanded beyond its facts) d. Facts California personal property tax on containers and there are containers associated with a Japanese Company Shipping companies contended that they were entitled to a refund because the taxes they paid to California were unconstitutional under the CC e. Held that Californias tax violated the two additional prongs of the CC The tax resulted in multiple taxation of the instrumentalities of foreign commerce because it produce multiple taxation in fact i. California had a right to tax its fair share, but the Japanese tax did not have to be proportional, so that is why this result. a. b.

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Californias tax placed impediments before the federal governments conduct of its foreign relations and its foreign trade.

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Chapter 3 - Commerce Clause Restrictions on S&L Taxation. a. Complete Auto (1977) TEST. 1) Substantial nexus with the taxing state; 2) Fair apportionment 100% of their income was being taxed, but no problem here as they were only operating in one state; 3) does not discriminate against interstate commerce; and 4) Is taxes fairly related to the services provided by the state? b. Nexus - Gross Receipts Taxes. Tyler Pipe Indus. (U.S. 1987). Tyler maintained no office, owns no property, and has no employees residing in the State of Washington. Its solicitation of business in Washington is directed by executives who maintain their offices out of state and by an independent contractor located in Seattle. The crucial factor governing nexus is whether the activities performed in the state on behalf of the company are significantly associated with its ability to establish and maintain a market in the state for its sales. The court found this standard was satisfied because Tyler's "sales representatives perform any local activities necessary for maintenance of Tyler Pipe's market and protection of its interests i. Tyler also asserts that the B & O tax does not fairly apportion the tax burden between its activities in Washington and its activities in other States. This apportionment argument rests on the erroneous assumption that through the B & O tax, Washington is taxing the unitary activity of manufacturing and wholesaling. We have already determined, however, that the manufacturing tax and wholesaling tax are not compensating taxes for substantially equivalent events in invalidating the multiple activities exemption. Thus, the activity of wholesaling-whether by an in-state or an outof-state manufacturer-must be viewed as a separate activity conducted wholly within Washington that no other State has jurisdiction to tax. Nexus via Affiliated Corps. Restatement says that just because subsidiary or parent, does not give state jurisdiction. Only if dominates sub so much as to disregard its separate corporate existence. New York Statute Establishing Presumption of Nexus With Online Retailers Who Pay Commissions to New York Residents Who Post Links on Their Web Sites. (TC Dismissed Amazon complaint as statute was carefully crafted to ensure there is sufficient basis for requiring collection. Additionally, activities of affiliates take place within NY, etc. See Attached Doc.) Sales and Use Taxes on Mail Order Vendors. Quill. The physical presence test articulated twenty-five years earlier in National Bellas Hess, Inc. remained the Commerce Clause substantial nexus standard, See III(A)(ii). i. Case may or may not be narrowed to this tax on this industry. ii. Physical Presence Standard not Substantial Physical Presence, but any physical presence according to NY Ct of Appeals. FA Ct disagreed. Jurisdiction to Tax Income. States power to tax income on the basis of source is as well recognized as power to tax on basis of residence. But when conflict between state of residence and state of source, latter wins.

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JC Penney National Bank v. Johnson (Tenn) held that an out-ofstate bank that did a substantial credit card business with Tennessee cardholders lacked the substantial nexus with the state that the Commerce Clause requires as a predicate for the assertion of state tax jurisdiction. a. JC Penney National Bank (JCPNB), a subsidiary of the JC Penney Company, is a consumer banking institution based in Delaware. It was engaged in credit card lending in Tennessee and other states through the issuance of credit cards. JCPNB maintained no offices or places of business in Tennessee, and had no employees in the state. JCPNB contracted with its parent, JC Penney, to perform various marketing and processing services that were necessary to create and maintain JCPNB's credit card business. JC Penney, in turn, contracted with other companies, all located out of state, to provide many of these services. None of these activities, other than the solicitations mailed to Tennessee residents, occurred in Tennessee. It paid an income tax to Delaware on 100 percent of its net income and had never filed a franchise or excise tax return in Tennessee. b. Relying on Quill and Bellas Hess, JCPNB argued that physical presence was required. The Commissioner of Revenue sought to distinguish those two cases on the ground that they involved use taxes rather than franchise and excise taxes. c. The court rejected the Commissioner's position: While it is true that the Bellas Hess and Quill decisions focused on use taxes, we find no basis for concluding that the analysis should be different in the present case. We are not in a position to speculate as to how the Supreme Court might decide future cases. We are only able to rely on past decisions. Any constitutional distinctions between the franchise and excise taxes presented here and the use taxes contemplated in Bellas Hess and Quill are not within the purview of this court to discern. As such, we feel that the outcome of this case is governed by Bellas Hess and Quill, as those decisions interpret the first prong of the Complete Auto test. d. The court agreed with JCPNB that the facts of the case were almost identical to the facts in Quill, and it dismissed the Commissioner's efforts to distinguish the case on factual grounds. e. The court found that the in-state presence of JCPNB's plastic credit cardswhich remained the property of JCPNB even though they were in the hands of its customerswas not constitutionally significant to find that bank had substantial nexus. It pointed out that the cards themselves were virtually worthless and were merely convenient articles on which to record the necessary information regarding the customers' accounts. [T]he real asset is the intangible account which the card represents, which were in the State of Delaware and not subject to a Tennessee tax. f. The court then dismissed the Commissioner's contention that JCPNB had a physical presence in the state by virtue of the fact that JCPNB's parent, the JC Penney Company,

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owned retail stores in the state as the retail stores were not affiliated with JCPNB's... credit card operations. g. Finally, the court rejected the Commissioner's contention, based on the U.S. Supreme Court's decisions in Scripto and Tyler Pipe, that a substantial nexus existed based on the activities of the affiliates and third parties working on JCPNB's behalf as both Tyler Pipe and Scripto involved the crucial element of physical presence, which is not present in this case. In those cases, activities were being conducted in the taxing state that substantially contributed to the taxpayer's ability to maintain operations in the taxing state. In contrast to the independent contractors acting on behalf of the out-of-state taxpayers in Scripto and Tyler Pipe, none of the third parties with which JCPNB contracted, directly or indirectly, to carry on its credit card operations performed any services on behalf of JCPNB in Tennessee. Geoffrey, Inc. (South Carolina Case) - EXPLOITATION OF INTANGIBLE PROPERTY RIGHTS IN THE STATE AS A BASIS FOR JURISDICTION TO TAX OUT-OF-STATE PERSONS DERIVING INCOME FROM SUCH PROPERTY a. The taxpayer was a Delaware corporation that had been organized for the purpose of holding and managing the trademarks of Toys R Us. Geoffrey licensed Toys R Us to use the trademarks in its United States business (except for five states). Under the license agreement, Toys R Us agreed to pay Geoffrey one percent of the net sales of products sold under the licensed mark. During the years at issue, Toys R Us earned income from its South Carolina operations (on which it paid South Carolina income taxes) and paid royalties to Geoffrey on those sales. (Delaware has no income tax, so saving money.) At no time did Geoffrey have any employees, offices, or real or tangible personal property in South Carolina. b. Court focused on due process claim, citing Quill. Although Toys R Us had no South Carolina stores when it entered into the trademark license agreement with Geoffrey, the court determined that Geoffrey had, nevertheless, purposefully directed its activities toward South Carolina [b]y electing to license its trademarks and trade names for use by Toys R Us (intangibles) in many states without prohibiting their use in South Carolina. c. The South Carolina Supreme Court disposed of Geoffrey's Commerce Clause claim by distinguishing Quill to only apply to sales and use taxes. The court concluded that Geoffrey had a substantial nexus due to the existence of state-provided protections and benefits and the presence of Geoffrey's intangibles in the state. Thus the court declared that any corporation that regularly exploits the markets of a state should be subject to its jurisdiction to impose an income tax even though not physically present and that [t]he presence of intangible property alone is sufficient to establish nexus.

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Hard to find any differences between due process analysis and commerce clause analysis. Public Law 86-272. No State shall have power to impose a net income tax on the income derived within such State by any person from interstate commerce if the only business activities within such State by or on behalf of such person during such taxable year are either, or both, of the following: a. the solicitation of orders by such person, or his representative, in such State for sales of tangible personal property, which orders are sent outside the State for approval or rejection, and, if approved, are filled by shipment or delivery from a point outside the State; and b. the solicitation of orders by such person, or his representative, in such State in the name of or for the benefit of a prospective customer of such person, if orders by such customer to such person to enable such customer to fill orders resulting from such solicitation are orders described in paragraph (1). a. The typical fact pattern toward which this paragraph is directed involves the out-of-state manufacturer/seller who makes sales to a local distributor who in turn sells the products to the manufacturer/seller's ultimate customer. 1. This pattern is particularly prevalent in the alcoholic beverages and pharmaceutical industries, where the out-of-state manufacturer is often precluded by law from selling directly to the ultimate consumer. c. Exceptions. a. The statute excludes from its scope the entire service sector b. If merely qualified to do business within state, most state courts hold this does not takes business out of 86272s scope as 86-272 only expressly mentioned a business being incorporate within state as taking it out of acts scope. d. Solicitation. In William Wrigley, Jr, Supreme Court construed the term solicitation of orders to include not only what is strictly essential to making requests for purchases but also those activities that are entirely ancillary to requests for purchases. a. Wrigley, a chewing gum manufacturer based in Chicago, sold its product in Wisconsin through a resident sales force. The resident sales representatives were provided with company cars, but not with offices. They were also furnished a stock of gum (with an average wholesale value of about $1,000), a supply of display racks, and promotional literature. b. In construing the meaning of the phrase solicitation of orders in Public Law 86-272, the Court began with the dictionary definition of solicitationasking for, enticing to, or approaching with a request or plea. The

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Court found it evident that in this statute the term includes, not just explicit verbal requests for orders, but also any speech or conduct that implicitly invites an order. Ct read the term as embracing not merely the ultimate act of inviting an order but the entire process associated with the invitation. It also avoided the extreme of restricting the protection of the statute only to day-trips into the taxing jurisdiction by empty-handed drummers on foot, a consequence of limiting solicitation of orders only to actual requests for orders. The Court likewise rejected the broad construction of the term that would treat as solicitation of orders' any activities that are ordinary and necessary business activities accompanying the solicitation process' or are routinely associated with deploying a sales force to conduct the solicitation, so long as there is no office, plant, warehouse, or inventory in the State. c. Once it is acknowledged that solicitation of orders covers more than what is strictly essential to making requests for purchases, the next clear line is the one between those activities that are entirely ancillary to requests for purchasesthose that serve no independent business function apart from their connection to the soliciting of ordersand those activities that the company would have reason to engage in anyway but chooses to allocate to its instate sales force, which would be unprotected d. De Minimis Activities. Notwithstanding the language of Public Law 86-272, the Court held that the law should be construed in light of the venerable maxim de minimis. The Court gave little content to the de minimis exception to Public Law 86-272's language other than its observation that whether in-state activity other than solicitation of orders is sufficiently de minimis to avoid loss of tax immunity conferred by 86-272 depends upon whether that activity establishes a nontrivial additional connection with the taxing State, i.e. selling one 10 cent stick of gum. e. . e. Sales office. The legislative history of the statute leaves little doubt that the maintenance of a sales office within the state designed to serve local solicitors takes the taxpayer outside the area of immunity from taxation. (Some cts even hold that if salesperson makes use of home as the business and display office of his or her out-of-state employer, no longer protected.) f. Independent sales representatives. The immunity statute extends to the use independent contractors soliciting orders or making sales of tangible property for the out-of-state vendor. To qualify, these brokers or independent sales representatives must represent more than one principal and hold themselves out as such sales representatives. Unlike the employee sales representative,

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the independent broker may complete sales in the state, that is, at least accept orders, and the maintenance by the independent sales representative of his or her own sales office will not affect immunity. c. Apportionment. Goldberg v. Sweet (U.S. 1989). Must be internally consistent and externally consistent. Internally consistent. A tax must be structured so that if every State were to impose an identical tax, no multiple taxation would result. Externally consistent. Asks whether the State has taxed only that portion of the revenues from the interstate activity which reasonably reflects the instate component of the activity being taxed. (Tax act in this case only reached calls which originate or terminate in state and charged to an Illinois address. Ct doubted whether states that have the signal merely pass through have sufficient nexus. Also doubts termination of a phone call gives sufficient nexus. Says only alternative nexus would be for termination or origination of call and place billed or actually paid within that state.) i. In previous cases. Endorsed apportionment formulas that based upon miles a vehicle travelled where it was practicable to keep track. But here, not practicable to keep track. d. Discrimination. Goldberg. i. The Illinois tax differs from the flat taxes found discriminatory in Scheiner in two important ways. First, whereas Pennsylvania's flat taxes burdened out-of-state truckers who would have difficulty effecting legislative change, the economic burden of the Illinois telecommunications tax falls on the Illinois telecommunications consumer, the insider who presumably is able to complain about and change the tax through the Illinois political process. ii. Second, whereas with Penn flat tax, could measure activities, cannot do so with thousands of electronic signals, which can be neither traced nor recorded. Halliburton Oil Well Cementing Co. (U.S. 1963). U.S. Supreme Court struck down Louisiana's sales/use tax differential in the case of equipment manufactured by a taxpayer outside the state for use within Louisiana. In holding that the tax violated the Commerce Clause, the Court declared that equal treatment for in-state and out-of-state taxpayers similarly situated is the condition precedent for a valid use tax on goods imported from out-of-state. i. The Court also observed that the tax was an incentive to locate within Louisiana, that it would tend to neutralize advantages belonging to the place of origin, and that, like the drummers' license taxes, the levy was discriminatory in favor of the local merchant. ii. One significant feature of the Halliburton case was the Court's position that it was irrelevant whether the discrimination was intentional or inadvertent. In Boston Stock Exchange. Ct found that NY was not allowed to give tax benefits to ppl for using NYSE. i. Court felt moved to observe that its decision...does not prevent the States from structuring their tax systems to encourage the growth and development of intrastate commerce and industry. The Court did not

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explain, however, how states could effectively pursue this objective under the constraints of its reasoning in Boston Stock Exchange. ii. Case pointed out that it did not matter that were discriminating against nonresidents in favor or residents, but nonresidents in favor of other nonresidents. Bacchus. Extent of competition irrelevant under Commerce Clause. i. Permitted to regulate alcohol, but state fee imposed as condition to transportation into jurisdiction illegal as hampered competition. ii. Wilson Act eliminated Commerce clause barrier, however, to the states police power over goods in the original package. Subsequent Act prohibited transportation of liquor into state in violation of its laws Complementary taxes as a defense to state tax discrimination under the commerce clause. For example, a use tax imposed on good purchased out of state to complement sales tax on goods purchased within state. But the ct did not favor tax on wholesaling meant to complement tax on manufacturing. i. Oregon Waste Systems. Ct insisted that the complementary exaction must be both identifiable and substantially similar. Three prong inquiry: a. The state must identify the intrastate tax burden for which the state is attempting to compensate. b. The tax on interstate commerce must be shown roughly to approximate, but not exceed, the amount of the tax on intrastate commerce. c. The events on which the interstate and intrastate taxes are imposed must be substantially equivalent (i.e., they must be sufficiently similar in substance to serve as mutually exclusive proxies for each other) Discriminatory Tax Credits Conditioned on Reciprocity by other States illegal. Ohio had limited tax credit to in-state producers or producers in other states that gave Ohios producers this benefit. Nondiscriminatory tax on In-State and Out of state Milk Dealers Coupled with a Tax Rebate limited to in-state milk producers illegal as ct said have to look at whole program making it disc tax. In Cuno, the Sixth Circuit struck down Ohio's income tax credit for new in-state investment on the ground that it discriminated against interstate commerce but at the same time sustained the state's personal property tax exemption for new in-state investment. i. Court agreed with the plaintiffs' argument that the income tax credit discriminated against interstate economic activity by coercing businesses already subject to the Ohio franchise tax to expand locally rather than out-ofstate. ii. When it came to the personal property tax exemption for property first used in business in the state, the court took a different view of the incentive's constitutionality under the Commerce Clause. Conditions required beneficiaries of the exemption to agree to maintain a specified level of employment and investment in the state. Exemptions raise no constitutional issues when the conditions for obtaining the favorable tax treatment are related to the use or location of the property itself.

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In other words, an exemption may be discriminatory if it requires the beneficiary to engage in another form of business in order to receive the benefit or is limited to businesses with a specified economic presence. However, if the conditions imposed on the exemption do not discriminate based on an independent form of commerce, they pass muster under the Commerce Clause. b. The court characterized the conditions imposed on the receipt of the Ohio property tax exemption as minor collateral requirements...directly linked to the use of the exempted personal property. The statute required only an investment in new or existing property within an enterprise zone and maintenance of employees. It did not impose specific monetary requirements, require the creation of new jobs, or encourage a beneficiary to engage in an additional form of commerce independent of the newly acquired property. iii. Finally, the court focused on the differences between tax credits and tax exemptions: Unlike an investment tax credit that reduces pre-existing income tax liability, the personal property exemption does not reduce any existing property tax liability. The exemption merely allows a taxpayer to avoid tax liability for new personal property put into first use in conjunction with a qualified new investment. Thus, a taxpayer's failure to locate new investments within Ohio simply means that the taxpayer is not subject to the state's property tax at all, and any discriminatory treatment between a company that invests in Ohio and one that invests out-of-state cannot be attributed the Ohio tax regime or its failure to reduce current property taxes. Severance Taxes. In Commonwealth Edison Co. v. Montana, the Court considered the constitutionality of Montana's 30 percent severance tax on coal that allegedly discriminated against interstate commerce because virtually all of the coal severed in Montana was destined for out-of-state consumption. In rejecting this approach, the Court observed that it had long...rejected any suggestion that a state tax or regulation affecting interstate commerce is immune from Commerce Clause scrutiny because it attaches only to a local or intrastate activity. Rather, the Court's goal [i]n reviewing Commerce Clause challenges to state taxes...has instead been to establish a consistent and rational method of inquiry focusing on the practical effect of a challenged tax, the Complete Auto test. Consequently, even though taxes may be levied on local activities that may not be regarded as interstate commerce, such taxes may substantially affect interstate commerce, and this effect is within the proper focus of Commerce Clause inquiry. i. There is no real discrimination since the tax is computed at the same rate regardless of the final destination of the coal and the tax burden is borne according to the amount of coal consumed, not according to any distinction between in-state and out-of-state consumers. e. Tax is fairly related to the presence and activities of the TP within the state Fourth Prong. Goldberg. The tax which may be imposed on a particular interstate transaction need not be limited to the cost of the services incurred by the State on account of that particular activity. On the contrary, "interstate commerce may be required to

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f.

contribute to the cost of providing all governmental services, including those services from which it arguably receives no direct 'benefit.'" in D. H. Holmes, supra, at 32, we noted that a taxpayer's receipt of police and fire protection, the use of public roads and mass transit, and the other advantages of civilized society satisfied the requirement that the tax be fairly related to benefits provided by the State to the taxpayer. i. In Nippert v. City of Richmond, the Court relied on the Commerce Clause in striking down a license tax laid by the City of Richmond, Virginia, on engaging in business as solicitors. The Court also emphasized the risks to the out-of-state vendor of the fixed-fee license tax required to be paid before any business is done and the burdens such a levy imposes on the small operator particularly and more especially the casual or occasional one. ii. Dunbar-Stanley Studios, Inc. v. Alabama involved the application of Alabama's license tax of on each transient or traveling photographer. The photographers sent the undeveloped film back to their North Carolina studios for developing. The business was conducted under a contractual arrangement between the taxpayer and JC Penney stores located in Alabama. The Penney stores advertised the services and recruited customers. The Court rejected the contention that the tax operated to discriminate against interstate commerce as Alabama's tax is levied equally upon all transient or traveling photographers whether their travel is interstate or entirely within the State. a. Hellerstein thinks this case is out of line with other drummer license cases. Commonwealth Edison Co severance tax. Because it is measured as a percentage of the value of the coal taken, the Montana tax, a general revenue tax, is in proper proportion to appellants' activities within the State and, therefore, to their enjoyment of the opportunities and protection which the State has afforded in connection with those activities, such as police and fire protection, the benefit of a trained work force, and the advantages of a civilized society. i. ct claimed that fourth prong closely connected with first. Measure of tax must be reasonably related to contacts with state as well. Bec. it is measured as percentage of resources withdrawn, the tax is in proper proportion to appellants activities. Foreign Commerce Clause Prongs. When a tax affects foreign commerce, it must satisfy two additional criteria. First, it must not create a substantial risk of international multiple taxation. Second, it must not prevent the Federal Government from speaking with one voice when regulating commercial relations with foreign governments. If a state tax contravenes either of these precepts, it is unconstitutional under the Commerce Clause. Japan Line was an ad valorem property tax case that actually involved multiple taxation and the Ct has never since invalidated another tax under foreign commerce clause.

Import/export clause

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Michelin v. Wages (Imports) GA's assessment of nondiscriminatory ad valorem property tax against the imported 7. tires is not against the import/export clause. 2. step - are goods still in transit? However must first lose their character as a. imports and become incorporated into the mass of property in the state. Original package doctrine, reexamined by this case. 1. step - is impost or duty? Or if the tax is nondiscriminatory. Tax not really on b. import, levy against all property (impost or duty) Did tax offend any of 3 policy concerns? 1 fed govt must speak with one voice; 2 import revenues were to be major source of revenue for fed govt; 3 harmony among state might be disturbed, prevent interstate rivalry and friction. Washington v. Stevedoring companies (exports)
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Chapter 4
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Chapter 4 - Uniformity and Equality Requirements. (1. state's uniformity clause in their constiution (apply to prop taxes) 2. Equal protection clause 3. Privileges/Immunities clause a. Classification Problems. Taxes vs. Fees. Because state uniformity and equality provisions generally apply only to taxes, the question often arises whether a particular exaction constitutes a tax that is subject to the constitutional restriction, or a fee or charge that need not be uniform or equal. i. Examples. a. The Arkansas Supreme Court, for example, held that a charge for a motor vehicle certificate of title was a fee rather than a tax and therefore was not subject to the state's constitutional uniformity and equality requirements. b. A residential street utility charge was a tax rather than a special assessment, because the charge was not levied for any specific improvements. ii. Factors courts use to distinguish taxes from fees include: a. whether the payment was voluntary (fee) or involuntary (tax); b. whether the payment was for a specific governmental benefit (fee) or for general governmental purposes (tax); c. whether the payment was made into a segregated fund (fee) or paid into the general treasury (tax); and d. whether the payment was imposed by a regulatory agency upon those subject to regulation (fee) or to defray general governmental expenditures (tax). Taxing Provisions Versus Spending Provisions. Because state uniformity and equality provisions address taxing rather than spending measures, the question

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may arise whether tax credits or other distributions are subject to uniformity and equality strictures. i. Examples. a. The South Carolina Supreme Court, for example, sustained a local option sales tax, whose proceeds were used to provide a property tax credit, because the state's uniformity and equality provision does not impose uniformity on the distribution of taxes. b. Other courts, however, have reasoned that [i]t is the effect of the statute, not the form, which determines whether it is a tax statute subject to the uniformity clause. a. On this basis, the Wisconsin Supreme Court struck down a property tax credit that was provided to offset increased property tax assessments attributable to building improvements but was limited to a specified group of qualifying property owners. Credit was in substance a tax statute because it has the effect of changing the individual tax burden by granting a partial exemption. Property Tax Classification Problems Arising Under Uniformity and Equality Provisions. If the clause only applies to property taxes under a constitution, for example, then you must ascertain first whether something is a property tax. Take the four examples below: i. Douglas Aircraft Co. Held that tax is excise tax levied on the privilege of use, storage, or consumption. a. Reasoning. Legislature called it an excise tax and it does not fall on owner as a result of him being the owner. ii. Dawson v. Kentucky. Involved similar statute and Supreme Court held that tax was on property and hence, violated States uniformity and equality clause. To levy a tax by reason of the ownership of property is to tax the property. a. Distinguished. Douglas tried distinguishing this case, saying it relied on some peculiar language in statute and legislative history. iii. Severance Taxes. Most courts have held this is an excise tax. iv. Income Taxes. Some states hold it is not tax on property, while others hold it is not, relying on the US Supreme Ct case of Pollock, which had held the 1894 federal income tax law unconstitutional. Its rationale, which the Massachusetts court adopted, was that a tax on income from land or personal property is a tax on the land or personalty itself. Differences in Treatment of TPs or Property under Uniformity and Equality Clauses. i. Examples. a. Some states. Cannot permit a tax deduction only to business giving compensation of less than 100k. Another example: cannot tax snacks from vending machines if not taxed when purchased from supermarkets. b. Most states permits classification of property, but the leeway granted to legislatures varies from state to state.

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Population based distinctions, i.e. only in counties with over 3M ppl, generally withstand const analysis. d. Geographical based distinctions, i.e. only applies to islands within jurisdiction, on the other hand, usually do not. b. Equal protection of the laws. The Equal Protection Clause of the Fourteenth Amendment: [N]or shall any State...deny to any person within its jurisdiction the equal protection of the laws. (Most state constitutions have a counterpart to this provision.) In 1886, the Supreme Court held that the term person, as used in the Equal Protection Clause (as well as in the Due Process Clause) of the Fourteenth Amendment, applies to corporations. Classification of Property and Taxpayers. Fitzgerald v. Racing 10. Different tax rates for similar but different enterprises. Subject to rational-basis review, old standard. Equal Prot satisfied so long as there is a plausible policy reason for the classification, legislative facts when making law were taken as true, and relationship of classification to its goal is connected. 11. Test: (1) Does the challenged legislation have a legitimate state purpose? and (2) Was it reasonable for the lawmakers to believe that use of the challenged classification would promote that purpose? 12. Standard. Accordingly, the only equal protection inquiry in tax cases is generally whether the State's classification is rationally related to the State's objective. a. Under this standard, a statute will be sustained if the legislature could have reasonably concluded that the challenged classification would promote a legitimate state purpose. Exxon. Prohibition plainly bore a rational relationship to the States legitimate purpose of protecting consumer from excessive prices. Id. b. The State may impose different specific taxes upon different trades and professions and may vary the rate of excise upon various products. c. Classification by gender. Sup Ct has held this is permissible if there is a rational basis, i.e. rationally promoted govt interests. d. Classified property tax. Permitted to have classified tax, and even to tax diff within same class if result of error or is shown not to be intentional. e. Discrimination in Real Property Tax Assessments. Allegheny held that tax assessors policy of only reassessing property recently sold violated the equal protection clause. Court seems to imply that it is deciding this way because West Virginia's Constitution and implementing statutes provided that all the property in question was to be taxed at a uniform rate throughout the state according to its market value. Assessment Regimes Based on Acquisition Value: California's Proposition 13. Court in Nordlinger upheld the California scheme on the ground that it rationally furthered the legitimate state interests of preserving and stabilizing neighborhoods and of protecting longtime owners' interests in avoiding higher taxes.

c.

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The Court distinguished Allegheny on the ground that, in contrast to the purposes that could have conceivably been the basis for California's regime, there was an absence of any indication in Allegheny that the policies underlying an acquisition value taxation scheme could conceivably have been the purpose of the Webster County assessor's unequal assessment scheme. Ct implied therefore, that had there been such an indication, they would have upheld it. Nashville, in dismissing a railroad's equal protection challenge to the valuation of its property said: If the discrimination of which the Railway complains had been formally written into the statutes of Tennessee, a challenge to its constitutionality would be frivolous. Here...all the organs of the state are conforming to a practice, systematic, unbroken [. . .] It would be a narrow conception of jurisprudence to confine the notion of laws to what is found written on the statute books, and to disregard the gloss which life has written upon it. f. Graduated Gross Receipts Tax. In Stewart Dry Goods Co. v. Lewis (Sup Ct), Kentucky imposed a license tax on retail merchants graduated according to gross sales. In invalidating the tax as repugnant to the Equal Protection Clause, the Court declared: [T]he operation of the statute is unjustifiably unequal, whimsical and arbitrary, as much so as would be a tax on tangible personal property, say cattle, stepped up in rate on each additional animal owned by the taxpayer, or a tax on land similarly graduated according to the number of parcels owned. Hellerstein inquires why this is different than income tax, where graduation is permitted. 13. Many states construe their uniformity and equality provisions differently than the Sup Ct construes the federal consts equal protection clause. Hence, they would come out differently than the Sup Ct. i. Property Tax disparities Nordlinger v. Hahn EP clause does not forbid classifications of different tax rates for different taxpayers. It simply keeps gov't decision makers from treating differently persons who are in all relevant respects alike. It must only rationally further a legitimate state interest. Separate Classification of Foreign and Domestic Corporations: The Insurance Company Cases. (Congress passed the McCarrant-Ferguson Act, which reinstated previous Sup Ct decisions that removed restraints of commerce clause on states in taxing the insurance industry.) While the CC has generally prevented the states from imposing burdensome or discriminatory taxes upon foreign corporations that seek to engage in interstate commerce within the state, insurance industry is an exception. Insurance industry does not constitute commerce within the meaning of CC b/c issuing a policy is not a transaction of commerce and insurance K's are not articles of commerce within any proper meaning of the word. SC overturned this thinking,

i.

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then congress passed bill to reinstate status quo that once again left states to tax insurance w/o CC constraints. Cant put more onerous taxes or other burdens on foreign corps than those imposed on domestic unless discrimination btwn foreign and domestic bears a rational relation to a legitimate state purpose. Court has held that the Equal Protection Clause afforded no protection to foreign corps that had not yet entered the state to do business on the ground that, until it did enter the state, it was not a person within a states jurisdiction. Consequently, ct has upheld fees on insurers as condition to obtaining license to operate in state. But once license obtained, it became entitled to equal protection of the laws. 1. Metropolitan Life Insurance Company. Supreme Court struck down an Alabama gross premiums tax, which had been imposed at a higher rate on foreign than on domestic insurance companies. The Court held that the tax failed to satisfy the principle enunciated in Western & Southern that more onerous taxation of foreign corporations than domestic corporations violates the Equal Protection Clause, unless the discrimination...bears a rational relation to a legitimate state purpose. a. In Western & Southern, the case principally relied upon [by state], we did not hold as a general rule that promotion of domestic industry is a legitimate state purpose under equal protection analysis. Rather, we held that California's purpose in enacting the retaliatory taxto promote the interstate business of domestic insurers by deterring other States from enacting discriminatory or excessive taxeswas a legitimate one. Alabama has made no attempt, as California did, to influence the policies of other States in order to enhance its domestic companies' ability to operate interstate; rather, it has erected barriers to foreign companies who wish to do interstate business in order to improve its domestic insurers' ability to compete at home. b. The second legitimate purpose advanced by the state was the encouragement of capital investment in Alabama assets and governmental securities. The Supreme Court rejected the defense on the ground that investment in the specified assets would not reduce the premiums tax of the foreign insurers to the low rate imposed on domestic insurers. Hence, the state's effort to encourage investment in this plainly discriminatory manner serves no legitimate state purpose. 2. Post Metropolitan Life retaliatory taxes in state courts. a. Some have followed Western to edge. The North Carolina courts held that a regulatory charge measured by insurance premiums did not need to be considered in determining relative tax burdens for retaliatory tax purposes. Similarly, the Michigan Supreme Court likewise sustained a retaliatory tax that excluded payments that insurers made to various private insurance associations and facilities from the determination of

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the tax burden that Michigan imposed on insurance companies. Found that the exclusion satisfied the rational basis standard for adjudicating equal protection challenges: The legislature could have believed that excluding payments to private insurance associations and facilities from the retaliatory tax calculation would encourage other states to establish similar associations and facilities, because the payments to such organizations would not affect retaliatory taxes that their domestic insurers paid to other states. b. In a few instances, however, the states have failed in their efforts to defend their retaliatory tax schemes against claims of unlawful discrimination. Separate Classification of Foreign and Domestic Corporations: The Non Insurance Company Cases. More than just does the tax turn on whether the corp is domestic or foreign. Can discriminate against own residents. In Wheeling Steel Corp. v. Glander (1949), Ohio sought to justify the taxing scheme as establishing a reciprocal structure that, if adopted by other states, would have resulted in the taxation of Ohio corporations' receivables from sales of goods shipped from manufacturing plants in such other states. The Supreme Court rejected this claim, observing: It is hard to see that this offer of reciprocity restores to appellants any of the equality which the application of the Ohio tax, considered alone, so obviously denies. There is no indication of a readiness by other states to copy Ohio's situs scheme so as to tax that which Ohio exempts. In Allied Stores of Ohio, Inc. v. Bowers (1959), an Ohio corporation contended that Ohio had denied it equal protection by exempting nonresident but not resident corporations from the state's property tax for merchandise and agricultural products kept in a storage warehouse within the state. The Court observed that the state may have been motivated in adopting the exemption by a desire to encourage the construction or leasing of warehouses in Ohio by nonresidents. The Court distinguished Wheeling Steel on the ground that the statutes at issue there declared their purpose to discriminate against nonresidents in order to create a scheme of reciprocity and thus left no room (as in Allied Stores) to conceive of a benign purpose for their existence. 1. Casebook suggestion that the only reason this case came out diff was because it involved disc against residents, while Wheeling involved discrimination against non-residents Discriminatory taxation of foreign corps as compared to Domestic Corps. WHYY, Inc. the Sup Ct held that once foreign corporations are admitted to the state, the adopted corporations are entitled to equal protection with the State's own corporate progeny, at least to the extent that their property is entitled to an equally favorable ad valorem tax basis. Denial of Charitable Exemptions or Deductions to Out-Of-State Charities. 1. The rationale behind these decisions denying deduction or exemptions is that out-of-state organizations do not meet the condition underlying the grant of tax exemption to in-state charitiesnamely, that they relieve the state of the costs and

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burdens of public functions it would otherwise have to perform, and that they perform other services benefiting the people of the state. a. That rationale appears adequate under the Equal Protection Clause to justify denying inheritance or income tax exemptions or deductions for gifts to out-of-state charities while permitting them for gifts to in-state charities. 2. However, when a foreign nonprofit corporation conducts charitable, educational, or other activities within the state and a domestic corporation conducting the same activities would be entitled to a tax exemption, a denial of an exemption to the foreign corporation violates the Equal Protection Clause. a. In WHYY, Inc. v. Borough of Glassboro, for example, the taxing authority denied a property tax exemption to a nonprofit corporation that operated an educational television station within New Jersey. Thirty percent of the television station's audience was in New Jersey. The Supreme Court overruled on the ground that once foreign corporations are admitted to the state, the adopted corporations are entitled to equal protection with the State's own corporate progeny, at least to the extent that their property is entitled to an equally favorable ad valorem tax basis. 3. Commerce clause problems. Moreover, even if the denial of an exemption to an out-of-state charity passes muster under the Equal Protection Clause, it may well violate the Commerce Clause, in light of the U.S. Supreme Court's decision in Camps Newfound/Owatonna, Inc. v. Town of Harrison, Maine. In that case, the Court held that the Commerce Clause prohibited the local taxing authority from denying a property tax exemption to charitable institutions that were operated principally for persons who were not in-state residents. In so holding, the Court reaffirmed the distinction between permissible and impermissible denials of tax exemptions to out-of-state charities under the Equal Protection Clause by observing that in Board of Education, where it had sustained the denial of an exemption for an out-of-state educational organization, none of the charitable activities of the legatee were performed in the [taxing state]. a. In that case, a bequest to a Kentucky charitable corporation did not qualify for an exemption from the Illinois inheritance tax because the corporate legatee was not incorporated in Illinois. In this case, the petitioner is a Maine corporation, and the validity of the portion of the Maine statute that denies the exemption to out-of-state corporations is not at issue. Moreover, unlike the situation in Board of Ed. of Ky., in which none of the charitable activities of the legatee were performed in Illinois, all of the benefits of attending petitioner's camp in Maine are bestowed within her borders. Discrimination against nonresident individuals.

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Denial of use tax credit for sales taxes paid by nonresidents. Vermont did not grant a credit for sales taxes paid on cars purchased in other states if the taxpayer was not a resident of Vermont when she purchased the car. In Williams v. Vermont, the U.S. Supreme Court held that the discrimination against nonresidents in Vermont's taxing scheme violated the Equal Protection Clause. The Court concluded: [W]e can see no relevant difference between motor vehicle registrants who purchased their cars out-of-state while they were Vermont residents and those who only came to Vermont after buying a car elsewhere. Limiting Tax Exemptions to Long-Term State Residents. 1. In Zobel v. Williams, for example, the U.S. Supreme Court held that the Equal Protection Clause forbade Alaska from making cash distributions to its residents when such distributions were graduated according to the number of years the individual had been a resident of the state. 2. In Hooper v. Bernalillo County Assessor, the Court considered the constitutionality of a New Mexico property tax exemption for Vietnam War veterans who were residents of the state before May 8, 1976. The Court held that the distinction between the two classes of resident veterans was not rationally related to the purposes New Mexico offered in support of the classification, and it struck the classification down under the Equal Protection Clause. a. New Mexico sought to justify the classification as an incentive to encourage Vietnam veterans to move to New Mexico. But the Court observed that the legislature established the eligibility date long after the triggering date occurred and that [t]he legislature cannot plausibly encourage veterans to move to the state by passing such retroactive legislation. Privileges and Immunities Citizens of each state shall be entitled to all privileges and immunities of citizens in the several states No state shall make or enforce any law which shall abridge the privileges or immunities of citizens of the US Limitations on the first one above. 1. Clause entitles nonresidents to be exempt from any higher taxes or excises than are imposed by the state upon its own citizens. Austin v. New Hampshire Established a rule of substantial equality of treatment for citizens of taxing state and nonresidents Effectively no resident of NH is taxed on out of state income, while out of state commuters are taxed on their NH income Tax not offset by other taxes imposed upon residents alone. Corporations are not citizens under this clause like they are under DP/CC P and I clause only embraces fundamental rights. Only to those P/I bearing upon the vitality of the nation as a single entity must the state treat all citizens alike. Lunding v. NY

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"When confronting a challenge under the P/I clause to a law distinguising between residents and nonresidents, a state may defend its position by demonstrating that (i) there is a substantial reason for the difference in treatment, and (ii) the discrimination practiced against nonresidents bears a substantial relationship to the state's objective. States may limit nonresidents' deductions of bizz expenses and nonbizz deductions based on the relationship btwn those expenses and instate propety or income. Simple reason as the fact that the expenses are clearly related to residence in another state May not catergorically deny a nonresident a deduction. Can limit to proportional to, or connected with, their income in the state.

Chapter 7 - Corporate Income Taxes State Corporate Income Tax Base Division of the Tax Base Apportionment by formula in general: Federal Constitutional Limitations 1. Apportionable Tax Base Hunt-Wesson v. Cali No functional integration, no economies of scale, no central management, therefore no enterprise unity. Can assign some functional expense w/o tracing or some other pro-rata system. States must have some reasonable way of assigning expenses to taxable v. non-taxable Fair Apportionment - what is fair? Whether the slice that the state seeks to tax is fair. Underwood Typewriter v. Chamberlain

Butler Bros v. McColgan Exxon Mobil v. Vermont Dividends non-unitary, taxed at headquarters.

1. 2. a. b. c.

CHAPTER 7: CORPORATE INCOME, FRANCHISE, AND CAPITAL STOCK TAXES Introductory Note The Development of State Corporate Taxes Most states impose annual franchise or privilege taxes on corporations. The states impose these taxes on the right to exist as a domestic corp On the privilege of doing business in the state as a foreign corp Or on the actual conduct or carrying on of business in the state by a corp.

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Capital Stock Tax: states generally impose franchise taxes measured by capital sock in addition to their general corporate income tax, except for those states that impose no corporate income taxes. a. The capital stock tax is typically an annual franchise tax, imposed on domestic corporations for the privilege of exiting as a corp and on foreign corps for the privilege of doing business within the taxing states. Net Income Tax most widely used measure of state corporate tax. a. This is a franchise tax measured by net income. Special Taxes on Selected Businesses States have traditionally singled out public utilities for special levies. Similarly, states righ in natural resources frequently impose severance taxes which are levies on the extraction of natural resources. a. Typically measured by gross receipts from or gross value of the product. b. Almost all states subject insurance companies to special taxes on their gross premiums apportioned to the state. Division of the Tax Base Introductory Note Issue a. To what extent can taxpayers base be assigned to a state. i. Start with the notion of federal corporate tax base (pie: Operating income) Allocation, Apportionment, and Separate Accounting these three factors can be jstufied as a rough indicator of either the source of a corporations income or capital stock bvalue or of the social costs that the corp generates. a. Allocation: attempts to trace the property, income, or receipt to the state of its source and to include the item in full in the measure of that states tax. i. i.e. in a corp capital stock tax, which ordinarily employs as its measure the value of the corporations assets in the state, the real and tangible personal property located in the state would be treated as a part of the corp property used and allocated to the state. ii. Bigger issue where property is intangible. iii. It is because of the difficulty of fixing a single situs of intangible assets and of attaching the entire income or receipts from sales to a single state that the states have largely rejected allocation of intangible assets under capital stock taxes and allocation of sales income under net income taxes. iv. A number of states apply allocation to rents and royalties from real estate and tangible personal property. b. Apportionment: The theory of apportionment by formula is that certain factors or elements of a business will fairly reflect the measure of the tax attributable to a state. i. The most widely used formula the states employ, the so called Mass formula, utilizes three factors: (1) REAL AND TANGIBLE PERSONAL PROPERTY, (2) PAYROLL, and (3) SALES ii. Historically the three factors were averages so that if a corp had 40% of its property ([property in state]/[total property], 35% of

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its payroll [payroll in state]/[total payroll], and 15% of its sales in the state [sales in state]/[total sales], its apportionment percentages would be 30% (i.e. (40+35+15)/3), and it would apportion 30 percent of its income or capital sock or other measure of the tax to the state. iii. Today roughly half the states put additional weight (usually double) on the sales factor, so that the corp described in the preceding point would have an apportionment factor of ~26% (40+35+15+15)/4 iv. Two Fundamental Inquiries Underlying Apportionment v. determination of the APPORTIONABLE TAX BASE (i.e. what property, income, or receipts are properly includable in the pie) a. Unitary Tax Principle: ask whether the state has a connection with the tax base. Trace to notion of something being a unit and due process nexus concept under a formula for apportionment, allowing state to look outside its borders to determine whats in the its borders. i. The test for the Unitary Business whether or not the operation of the portion of the business within the state is dependent up or contributory to the operation of the business outside the state. If there is such a relationship the business is unitary (From Exxon, pg 448) vi. Once on has delineated the apportionable tax base next determine the ACTUAL PERCETAGE of the tax base that should be apportioned to the state. a. This inquiry depends on whether the slice of the taxpayers apportionable pie that the state has attributed to itself by formula in fact reasonably reflects the activities that the taxpayer is carrying on within the state with respect to that tax base. c. Separate Accounting: generally limited to the division of income as distinguished from other tax bases of the multi-state business. i. Seeks to treat the taxpayers business activities conducted within the state separately from its out f state business activities and to compute its income as if the income producing activities were confined to the taxing state. ii. The essential problem with separate accounting is that while it purports to isolate portions of income received in various states, it may fail to account for contributions to income resulting from functional integration, centralization of management, and economies of scale. 4. Section 1: Apportionment By Formula in General: Federal Constitutional Limits 5. Generally a. States have broad leeway in adopting particular division of tax base subject to constraints of DP and CC in taxing NO more than fair share of property, income, or receipts of multi-state enterprise. i. Constitutional Question: whether tax based fairly apportioned to the taxing state inquiry depends on whether the slice of the taxpayers apportionable pie that state attributed to itself by formula

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b.

6. a.

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IN FACT reasonably reflects the activities that the taxpayer is carrying on within the state with respect to the tax base ii. If the taxpayer can demonstrate that the property/income/receipts assigned to the state by formula BEAR NO REASONABLE RALATIONSHIP to the taxpayers local presence/ activities then DP and CC will prevent state from taxing the tax base assigned to the state by formula It is alright to look outside the state because of the UNITARY THEORY. Once decide what appropriate apportionable base, determine the appropriate portion of the pie i. REMEMBER you can only look beyond the borders if there is a connection. Apportionable Tax Base Fargo v. Hart, pg 443 (an ad valorem property case) i. Facts ii. the Indiana Bd of Tax Commissioners assessed a tax on the companys property based on the unity principle whereby all the companys property was valued and a proportion of the whole value was imputed to property within the state based on the ration of the number of miles operated in the state to the total mileage. iii. The express company filed a return with the state enumerating the property used in its business, its location, and value, but the board based the assessment on all the assets of the company including its stocks, bonds, and securities located outside the state. iv. The court said if property used in connection with business, it is alright. The crucial question is NOT the physical location of the property, JUST that a connection with the interstate business. v. Here vi. no due process connection with the bonds bonds were NOT part of the pie that state has connection with. The state can tax what has due process connections to pie the fair apportionment of that . a. Bonds are not related to the ongoing operation of business not related to underlying operations. b. State may NOT TAX corporate income derived from UNRELATED business activity Exxon Corp v. Wisconsin Dept of Rev, pg 446 (an income case) i. Facts ii. Appellant oil corp sought review of judgment upholding appellee state department of rev, contending application of the statutory apportionment formula to total tax derived from a vertically integrated corporate structure doing business in several state a. They said this violated DP iii. Because its marketing operation was an integral part of a unitary business, they applied the states apportionment formula to the companys total income and assessed a tax liability against the company. iv. Appellant further argued the application of the formula to income derived from oil extraction located outside the state was inappropriate.

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Held the court upheld the tax to oil corporations total income derived from conducting business in several states because apportionment was not violative of due process when a sufficient nexus existed between appellants unitary business and interstate activities (appellants internal functional accounting was not binding on appellee. DP: 2 requirement for such taxation 1st minimal connection (nexus) establish if the business avails itself of the privilege of carrying on business in that state 2nd rational relationship between the income attributed to the state and the intrastate values of the enterprise. The test for the Unitary Business whether or not the operation of the portion of the business within the state is dependent up or contributory to the operation of the business outside the state. If there is such a relationship the business is unitary. Because many items sold in Wisconsin obtained through central office in Texas whose obvious purpose was to increase overall corporate profits through bulk purchases and allocation from supplies among retailers sales facilitated through uniform credit card system, packaging, bank names, promo displays ALL RUN FROM HQ. In order to exclude certain income from the apportionment formula, the company must prove that the income was earned in the course of activities unrelated to the sale of petroleum products in that state. Allied Signal v. Director, Div of Tax, pg 452 Facts a corporate taxpayer incorporated in Del and having headquarters in Michigan sold some stock in a mining company headquartered in NY and realized a gain of 211.5 million. The state of NJ, where the taxpayer built products, collected income tax on an apportioned share of that amount. After New Jersey assessed the Delaware corporation for income taxes on an apportioned amount of income that included in the base the income from the stock sale, the Delaware corporation sued for a refund in the New Jersey Tax Court. A unitary business may exist without a flow of goods between the parent and subsidiary, if instead there is a flow of value between the entities. The payee and the payor need not be engaged in the same unitary business as a prerequisite to tax apportionment in all cases. What is required instead is that the capital transaction serve an operational rather than an investment function. Held Court said important determination: DONT HAVE TO LOOK AT 2 BUSINESSES AS STAND ALONE IF INVESTMENT USED INTEGRALLY IN THE BUSINESS. the stipulated facts made clear that under Supreme Court precedents, New Jersey did not have the constitutional power to

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include in the Delaware corporation's tax base the income from the stock sale, where none of the three factors(1) functional integration, (2) centralization of management, and (3) economies of scale--focused on as indicators of a unitary business in a prior Supreme Court case were present. a. (from online): the "unitary business principle"-which, pursuant to the requirements of the Federal Constitution's commerce clause (Art I, 8, cl 3) and the due process clause of the Federal Constitution's Fourteenth Amendment, permits states to tax a corporation on an apportionable share of the multistate business carried on by the corporation in part in the taxing state if the business is unitary--is an appropriate device for ascertaining whether a state, in taxing the income of a nondomiciliary corporation, has transgressed its constitutional limitations b. the stipulated facts made clear that under Supreme Court precedents, New Jersey did not have the constitutional power to include in the Delaware corporation's tax base the income from the stock sale, where none of the three factors--functional integration, centralization of management, and economies of scale--focused on as indicators of a unitary business in a prior Supreme Court case were present. Notes The Definition of an Operational Function: in adopting an apportionability standard based on whether the asset serves an operational rather than an investment function in the taxpayers business, the court declared that the operational function criterion is once which focuses on the objective characteristics of the assets use and its relation to the taxpayers activities within the state Short term vs Long term investments: The court appears to emphasize the short term character of an investment as affecting whether it serves an operational or an investment function. Hunt-Wesson v. Franchise Tax Board of Cali, pg 467 Facts a state can tax a proportionate share of a unitary business. However, a state CANNOT tax non-unitary income received by a non-domiciliary corporation from an unrelated business activity which constituted a discrete business enterprise. Californias unitary system for determining the states taxable share of a multistate corporations business income authorized a deduction for interest expense, but generally permitted use of that deduction ONLY to the extent that the amount exceeded certain out of state income arising from the unrelated business activity of a discrete business enterprise. (essentially refusing deduction that would decrease your taxable base by that untaxable income and then can tax more of your money in essence taxing untaxable income). A corporation was a successor in interest to a nondomiciliary business of California that incurred interest expense during the years at issue.

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California disallowed the deduction for that expense insofar as the nondomiciliary business had received relevant nonunitary dividend and interest income. The successor corporation challenged the constitutional validity of the disallowance. Held Californias interest deduction offset provision constituted impermissible taxation of income outside the states jurisdictional reach, in violation of the due process clause and the commerce clause the provision a. Denied a taxpayer use of a portion of a deduction from unitary income b. Measured the amount of additional unitary income that became subject to taxation by precisely the amount of nonunitary income that a taxpayer had received c. And assumed that a corporation that borrowed any money at all had really borrowed that money to purchase or carry the corporations nonunitary investments. Notes The States approaches to expense allocation a. States employ a variety of methods for assigning expenses to taxable and nontaxable income i. Some states employ direct tracing rules under which expenses are denied when they can be traced directly to the generation of exempt income ii. Other state employ pro rata rule (based for example o nth ration of nontaxable income to total income or to assets generating nontaxable income to total income producing assets) iii. Some employ somewhat arbitrary percentage allocations or some combo of direct tracing and pro rata allocations. Fair Apportionment, pg 472 Introductory Note This addresses the question of whether the slice that the state seeks to tax is fair. In reading cases ask yourself whether there was any argument that could have been made that the tax base was not apportionable because the income did not arise from unitary business Underwood Typewriter v. Chamberlan, pg 473 Facts taxpayer del corp brought an action to recover the corp tax assessed and paid to Conn by the taxpayer under protest. Taxpayer challenged the comprehensive system of corp taxation on the grounds that it violated the taxpayers rights. Connecticut manufactures/ sales and ship outside the state. There was also additional business outside the state Held

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vi.

vii.

the tax did not produce an unreasonable result. The main issue was whether the Connecticut formula: (FMV of tangible personal property)/ (FMV of total personal property) x Income. Court said Profits earned by series of transactions beginning with manufacture in Connecticut and ending with sale on other states are reasonably attributable to income, and it would be impossible to allocate specifically when you have a unitary business. By definition one CANNOT know where the income is earned. a. This does not mean separate accounting is wrong, BUT a state can reasonably include when unitary business, and they can pick a reasonable method. b. ****Ultimately there is nothing that the state has to prove as long as unitary business AND reasonable formula. It is not enough for ot march in with separate accounting because no one knows and state entitled to use formula apportionment. Hans Rees Sons v. NC, pg 475 (NOT IN BOOK) Facts Foreign taxpayers ONLY manufacturing facility was in NC, and it conducted an operation in which it bought raw material, manufactured it into finished product, and sold that finished product through wholesale and retail channels. The fact that the corporate enterprise is a unitary one, in the sense that the ultimate gain is derived from the entire business, does not mean that for the purpose of taxation the activities which are conducted in different jurisdictions are to be regarded as component parts of a single unit so that the entire net income may be taxed in one state regardless of the extent tio which it may be derived from the conduct of the enterprise in another state. when, as in this case, there are different taxing jxns, each competent to lay a tax with respect to what lies within, and is done within, its own borders, and the question is necessarily one of apportionment, evidence may always be received which tends to show that a state has applied a method which, albeit fair on its face, operates so as to reach profits which are in no just sense attributable to transactions within its jurisdiction. It is sufficient to say that, in any aspect of the evidence, and upon the assumption made by the state court with respect to the facts shown, the statutory method, as applied to the appellants business operated unreasonably and arbitrarily, in attributing to NC a percentage of income out of all appropriate proportion to the business transacted by the appellant in that state. The NC taxpayer came in with specific evidence of where the income was earned it was able to demonstrate the formulaic approach was unreasonable. **This is the only case to hold a formulaic approach to a unitary tax base is unacceptable because it is so hard to make that case

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viii. ix.

d. i.

ii. iii. iv.

v.

vi. vii. viii. ix.

x.

xi.

Notes Distributing Profits Under Separate Accounting a. Taxpayer here offered to establish the portion of the profit allocable to buying manuf and selling. Two methods used to separate the manufacturing profit from selling profit i. Ascertain the actual cost of manufacturing and add a reasonable profit determined by reference to profit made by other corps, opinions etc. The goods are then deemed to have been sold by the manuf dept to the selling dept at the price indicated. Specific costs of each dept are determined and overhead, admin, and other general expenses are charged to the various depts. Theupon the allocable profit is determined ii. Ascertain the price at which the article manuf may be purchased from other manuf in the quantities desired. Utilize this figure as the cost of goods and otherwise proceed as indicated above. Butler Bros v. McGlogan, pg 483 A state in attempting to place upon a bizz extending into several states its fair share of the burden of taxation is faced with the impossibility of allocating specifically the profits earned by the processes conducted within its borders. All the factors in that enterprise are essential to the realization of profits (even if other parts are located outside the state). Facts the corporation challenged the act as applied the acts tax was applied to corps doing business within the state and the tax was measured by the corps net income for the preceding year. Because the corp consisted of many parts, only one of which was within Cali, it was difficult to discern the portion of net income attributable to Cali. A wholesale merchandise corporation operated, as a unitary business, stores in several States, including one in California. It maintained a central buying division which served all the stores. In 1935, it had a substantial profit, although the California store, on a separate accounting basis, showed a loss. The tax commissioner of California allocated to that State a percentage of the net income, and based thereon a tax under the state Bank and Corporation Franchise Tax Act. That percentage was determined by averaging the percentages which (a) value of real and tangible personal property, (b) wages, salaries, commissions and other compensation of employees, and (c) gross sales, less returns and allowances, attributable to the California store bore to the corresponding items of all the stores. Held

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xii. amendment. xiii.

The formula of apportionment did NOT violate the 14th

The fact that the accounting system of the Cali branch attributed no net income to that state did NOT prove that the tax was on extraterritorial values, since accounting practices for income statements may vary considerably according to the problem at hand, and a particular accounting system, though useful or necessary as a business aid, may not fit the different requirement when a state seeks to tax values created by business within its borders. xiv. The centralize purchasing resulted in more favorable prices. xv. In the application of a state statute imposing on corporations doing business within and without the State a franchise tax measured by a percentage of the net income derived from business within the State, a formula which is "fairly calculated" to allocate to the State that portion of the net income "reasonably attributable" to the business done there satisfies the requirements of the Fourteenth Amendment. xvi. One who attacks a formula for determining, under a taxing statute, the amount of net income allocable to the State, has the burden of showing by clear and cogent evidence that it results in extraterritorial values being taxed. xvii. Notes xviii. The Weakness of Separate Accounting as a basis for challenging Unitary Apportionment a. Sep Acct is vulnerable because it operates in a universe of unreality. For the essence of the sep acct technique of dividing the income of a unitary bus is to ignore the interdependence and integration of the bus operations. e. Norfolk and Western v. Mo State Tax Commission, pg 489- ad valorem case on rolling stock. i. Facts ii. lessee railroad agreed to pay taxes that were assessed against property that it leased from the lessor railroad. iii. The lessee railroad was an interstate shipper and the leased rolling stock comprised some eight percent of the total of all of its rolling stock and around three percent by number of units of its fleet. 1. The value of the lessee railroad stock was calculated based upon the value of all of the lessee railroads rolling stock, wherever located. 2. Evidence reflected that the assessed value greatly exceeded actual value. 3. The Formula they used: (miles in Mo/total miles)x (value of all rolling stock, regardless of where located). i. Held ii. since the commissions use of the mileage formula yielded a groslsly distorted result in the assessment of the taxpayers rolling stock, and since the difference between the assessed value and the actual value was too great to be explained in terms of an assumed and

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iii.

iv. 1.

b. 1. 2. 3. 4.

5.

6.

non-particularized enhancement of intangible value, the assessment violated the DP and CC. this is an example whereby separate accounting analysis that there is too much being attributed to Mo by the formula and this is just another example of where a formula where excessive is struck down. Notes Facial Attacks on Apportionment Formulas: The Single Factor Gross Receipts Formula for apportioning income a. GMC v. DC, pg 496 - DC had single factor sales formula and GMC sold cars in DC 2% sales so assigned 2% inc to district i. DC statute that could only be a portion fairly attrib to any bus engaged in the district ii. Ct said single factor formula looked only to sales violated statute which req other factors, prop and payroll be included iii. Given fact that all states 3 factor creates prob that one state out of line, prob of multiple taxation iv. Suppose mnfct in state A (single factor prop formula) and sell in state B (single factor sales formula): then Corp $100 fed inc assigned to each state based on diff formulas Moorman Manufacturing v. Bair, pg 497 Facts a manufacturing company, based in Ill, was engaged in the manufactur and sale of animal feeds in the state of Iowa as well. Sales in Iowa accounted for ~20 percent of the manufacturers total sales. The state of Iowa, for yeard, had allowed the manufacturer to compute its Iowa income based on weighted property, payroll, and sales factors. However, the state tax commission changed its procedure and assessed the manufacturer's taxes by using a single-factor sales formula. The director of revenue revised the manufacturer's assessment upward for five fiscal years. a. The new single factor test was based on (sales in state)/(total sales). Held a. the Iowa single-factor sales formula did not violate the due process clause as resulting in extraterritorial taxation, since i. the taxpayer had failed to show that a significant portion of the income attributable to Iowa was in fact generated by the taxpayer's operations in Illinois, ii. even assuming that the taxpayer's Illinois activities made some contribution to the profitability of the sales in Iowa, nevertheless the Constitution did not

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invalidate an apportionment formula merely because it might result in taxation of some income that did not have its source in the taxing state, and iii. the taxpayer had failed to avail itself of the opportunity provided by the Iowa statute to show that the single-factor formula produced an arbitrary result in the taxpayer's case; and b. **(this case really about the CC)** the Iowa single-factor formula did not violate the commerce clause on the ground that income derived from sales within Iowa was also taxed by Illinois under its three-factor formula, since i. the taxpayer had failed to establish any duplicative taxation in fact, ii. even assuming some overlap in taxation, it could not be concluded that the single-factor formula, rather than the three-factor formula, was at fault in a constitutional sense, and iii. the taxpayer had failed to show, under the Iowa statute, that the single-factor formula produced an arbitrary result in the taxpayer's case. 7. Dissent 8. 3 factor formula improvement over single facto and reflect reality more accurately, commercial advantage to Iowa bus b/c Iowa attributes to itself all inc from sales BUT other states tax portion through payroll/prop attribution 9. Notes 10. The Big Question a. How do you know if a taxpayers separate accounting evidence will be sufficient to invalidate the application of the states formula as a matter of con law? i. It is unusual to be able to id the source of the income. If you have a unitary real estate business, nevertheless he has a huge gain from selling a single property in one state that case you can say the synergies are not enough to allow a state to apportion it. 2. Section 2: Apportionment By Formula As Applied to the Multi-corporate Enterprise: Federal Constitutional Limits 3. Generally a. The focus in this section is on the broad federal constitutional constraints on apportionability and fair apportionment of the multi-corporate enterprise. 4. Mobil Oil Corp v. Commissioner of Taxes of Vermont a. Facts 1. A corporation organized under the laws of New York, having its principal place of business and its "commercial domicile" in New York, conducted its business in many states, including Vermont, where it marketed petroleum products.

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b. c.

d.

e.

Although Vermont's corporate income tax, calculated by a means of an apportionment formula, was imposed on taxable income as defined by federal law, the New York corporation, on its Vermont tax returns, subtracted from federal taxable income items it regarded as "non-apportionable," including net dividends received by the New York corporation from its subsidiaries and affiliates operating abroad. 3. The foreign subsidiaries paid dividends to Mobile NY. 4. The Vermont Department of Taxation recalculated the New York corporation's income by restoring the asserted nonapportionable items to the pre-apportionment tax base, and assessed the corporation for deficiencies plus interest. 5. The corporation challenged the deficiency assessments before Vermont's Commissioner of Taxes, arguing, among other things, that taxation of the dividend receipts under Vermont's corporate income tax violated the due process clause of the Fourteenth Amendment, as well as the commerce clause of the Federal Constitution. ISSUE: Can Vermont, where Mobile is NOT domiciled, can include these dividends within the taxbase of Mobile USA. Vermont saying entire bus from oil rigs in Venezuela to Vermont gas station one big unitary bus and if that so then dividends part of apportionable tax base Mobile argued NO nexus between dividends and Vermont- but rather this was a case of multiple taxation 1. Dividends could be fully taxable in NY Held 1. Vermont's taxation, by means of an apportionment formula, of the income received by the New York corporation in the form of dividends from subsidiaries and affiliates doing business abroad did not violate 2. the due process clause of the Fourteenth Amendment, since there was a satisfactory nexus between the corporation's dividend income and its business activities in Vermont, neither the "foreign source" of the income nor the fact that it was received in the form of dividends differentiating it from operating income on which a state could impose a fairly apportioned income tax, or 3. the commerce clause of the Federal Constitution, the Vermont tax not burdening interstate commerce because of its effect relative to the corporation's tax liability in other states, since although the corporation's state of domicile might have the authority to tax the corporation's dividend income, its authority was not exclusive, in that the dividend income bore a relation to benefits and privileges conferred by several states so as to render apportionment, rather than allocation, an acceptable method of taxation, and such tax also not imposing a burden on foreign commerce, in that the risk of multiple taxation abroad did not require the allocation of foreign source income to a single situs at home. 4. Foreign source dividends are NOT exempt as a matter of DP Vermont was taxing income, NOT ownership, so ok to tax proper share of dividend inc

2.

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5. 6. 7.

8. f. 1. 2.

3.

4. 5.

6.

7.

8.

must show that income earned in course of activities unrelated to the sale of petroleum products in that state. as long as dividends from subsidiaries reflect profit from integrated enterprise then income to parent earned in unitary business. The court emphasized substance over form substantively this is a unitary business. a. This was a parent subsidiary relationship Mobil could have liquidated all their subsidiaries and just created one big world wide entity so its substance over form, and Vermont has a right to tax a piece of that. We wont let the form of dividends if they reflect part of a unitary income stream, a non-domiciliary estate has the right to tax it. Factors of unitary business: functional integration, centralization of management and economies of scale Notes Asarco v. Idaho State Commissioner, pg 533 ISSUE: Whether Idaho could include within the apportionable tax base of a non-domiciliary corp the intangible income that the corporation derived fro, its investments in subsidiaries. a. Analysis was to see if the taxpayer failed in providing that the divided payors at issue are not part of its unitary business, but rather are discrete business enterprises. In sustaining the taxpayers claim in ASARCO, the court focuses on two features of the unitary business principle that precluded apportionability of the income at issue. a. Discreet business conducted by the out of state b. Court bars the apportionment of income from intangibles when the business activities of the payer have nothing to do with the activities of the recipient in the taxing state. Woolworth v. Taxation and Revenue Department, pg 536 ISSUE: whether a state could include within the apportionable tax base of a non-domiciliary corporation the intangible income that the corporation derived from its investments in subsidiaries. The dispute centered on the dividends that Woolworth received from four foreign subsidiaries which operated out of the country. a. They conducted the same type of general business in their respective countries as in the US Court reinforced ASARCO Could not apportionably tax it. a. The possession of large assets by subsidiaries is a business advantage of great value to the parent it may give a standing which shall facilitate purchases, it may enable the corporation to enlarge the field of its activities and in many ways give it business standing and prestige. the court held it was not unitary there was no centralized management, no economies of scale, no functional integration why because Woolworth Germany was operated separately

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5. a.

b.

c.

d.

e.

Container Corp v. Franchise Tax Board, pg 538 Facts 1. The corporation alleged that even if its operations and those of its foreign subsidiaries constituted a unitary business for purposes of the states tax, certain salient differences among national economies rendered the standard 3 factor apportionment formula used by the authority so inaccurate as applied to it to violate the constitutional requirement of fair apportionment. 2. A corporation brought a suit in California Superior Court for a refund of its state taxes, alleging that the corporation should not treat its overseas subsidiaries as part of its unitary business. 3. California imposed a corporate franchise tax geared to income, employing the unitary business principle and formula apportionment in applying that tax to corporations doing business both inside and outside the state. 4. A California statute applied a three-factor formula to apportion the income of a unitary business, based on the proportion of the unitary business's total payroll, property, and sales located in the state. Essentially what California does is eliminate transactions to get to a single tax base federal consolidated return is based entirely on legal ownership. If its a domestic corp and the parent owns more than 80 percent of the subsidiary it can be consolidated. Unitary Business: Appellant urges us to adopt a bright-line rule requiring as a prerequisite to a finding that a mercantile or manufacturing enterprise is unitary that it be characterized by "a substantial flow of goods." Brief for Appellant 47. We decline this invitation. The prerequisite to a constitutionally acceptable finding of unitary business is a flow of value, not a flow of goods. A relevant question in the unitary business inquiry is whether "'contributions to income [of the subsidiaries] [resulted] from functional integration, centralization of management, and economies of scale.'" "[Substantial] mutual interdependence," can arise in any number of ways; a substantial flow of goods is clearly one but just as clearly not the only one. 1. A leading scholar has suggested that a "flow of goods" requirement would provide a reasonable and workable bright-line test for unitary business 2. When you have a unitary business who knows where the income came from? Its like slicing a shadow. Held 1. The application of the unitary business principle was proper 2. The use of the three factor formula to apportion the income of the unitary business did NOT violate the constitutional requirement of fair apportionment 3. The tax did not violate the CC Distinguish Japan Line 1. Similar to JL

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2.

3.

4. 5.

6. 7.

8.

9.

10.

The tax imposed here, like the tax imposed in Japan Line, has resulted in actual double taxation, in the sense that some of the income taxed without apportionment by foreign nations as attributable to appellant's foreign subsidiaries was also taxed by California as attributable to the State's share of the total income of the unitary business of which those subsidiaries are a part. That double taxation stems from a serious divergence in the taxing schemes adopted by California and the foreign taxing authorities. The taxing method adopted by those foreign taxing authorities is consistent with accepted international practice. Our own Federal Government, to the degree it has spoken, seems to prefer the taxing method adopted by the international community to the taxing method adopted by California. Different from JL This involves a tax on income rather than a tax on property. We distinguished property from income taxation in suggesting that "[the] reasons for allocation to a single situs that often apply in the case of property taxation carry little force" in the case of income taxation. The double taxation in this case, although real, is not the "[inevitable]" result of the California taxing scheme. In Japan Line, we relied strongly on the fact that one taxing jurisdiction claimed the right to tax a given value in full, and another taxing jurisdiction claimed the right to tax the same entity in part -- a combination resulting necessarily in double taxation. Here, by contrast, we are faced with two distinct methods of allocating the income of a multinational enterprise. The "arm's-length" approach divides the pie on the basis of formal accounting principles. The formula apportionment method divides the same pie on the basis of a mathematical generalization. Whether the combination of the two methods results in the same income being taxed twice or in some portion of income not being taxed at all is dependent solely on the facts of the individual case. The tax here falls, not on the foreign owners of an instrumentality of foreign commerce, but on a corporation domiciled and headquartered in the United States. We specifically left open in Japan Line the application of that case to "domestically owned instrumentalities engaged in foreign commerce," and -- to the extent that corporations can be analogized to cargo containers in the first place -- this case falls clearly within that reservation. In Japan Line, the taxing State could entirely eliminate one important source of double taxation simply by adhering to one brightline rule: do not tax, to any extent whatsoever, cargo containers "that are owned, based, and registered abroad and that are used exclusively in international commerce . . . ." To require that the State adhere to this rule was by no means unfair, because the rule did no more than reflect consistent international practice and express federal policy. In this case, California could try to avoid double taxation simply by not taxing appellant's income at all, even though a good deal of it is plainly domestic.

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But no party has suggested such a rule, and its obvious unfairness requires no elaboration. Or California could try to avoid double taxation by adopting some version of the "arm's-length" approach. That course, however, would not by any means guarantee an end to double taxation. a. three factors that weighed in favor of the taxing state i. does not create automatic asymmetry ii. tax was not on a foreign entity iii. appellant is without a doubt amenable to be taxed in CA in one way or another and the tax is much more based on CA general tax rate more than its allocation iv. NOTE: executive branch did not file an amicus against the tax

1.

2.

3.

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11. Chronological Review 1978 Moorman single factor sales; 1980 Exxon/Mobil; 1982 Asarco/Woolworth; 1983 Container------ period of uncertainty how unitary principle applied --- 1992 Allied Signal directly address notion of apportionability to single entity Mobile, Asarco and Woolworth all present technically the same Question. Each case corporation domiciles in NY and a state saying that entitled to include in their apportionable tax base the income that a company NOT domiciled in their state BUT clearly doing bus there (have nexus). NO question that w/ regard to domestic operations that state entitled to take proportion of inc BUT question whether could also include in apportionable tax base the dividend inc received in NY? All three doing bus in US, unitary US operations a. Mobile: gas station Vt, receives dividends from foreign subs, sep corps Vz/SA b. Woolworth: retail store in NMx, WW UK, Canada foreign subs paying dividends to WW US c. Asarco: mine in Idaho, Peru, subs dividends, interest and capital gain Separate company reporting: respect for the separate corp entity NO effort to force group of unitary entity to file on consolidated basis a. BUT still want include things that take form of sep payment st 1 case Mobile: multi-corp enterprise, argue that foreign source dividends NOT related, Why? b/c not related to Vt activities, saying if treat company as worldwide unitary petrol bus you could do so a. technical argument that irrelevant that unitary, that if you want to say that Mobile is txpyr then respecting that form and relationship to rest of unitary bus and that relationship one where we as parent corp receive dividend inc then have to treat consistent as single unitary bus and if want to bring in dividend inc then eliminate all inter-co trxn and could ALL inc and all factors: if do this Vt get smaller and denominator gets really big (world wide payroll, sales, prop) b. Ct says NOT form that matters BUT underlying unitary nature, so long as dividend reflect profits from functionally integral enterprise look at

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6.

7.

8.

9.

10.

underlying activity NOT form of investment, just need unitary bus and dividends NO less unitary still part of integrated enterprise substance govern over form c. How can it be fair to have inc come into taxbase but NOT reflect it in the factors? Ct not even decide if this correct or not FN 15, not address the question d. DISSENT: ct say mobile NOT challenge fairness of 3 factor formula (esp a/f Butler/Exxon) BUT Mobile is NOT saying that formula is fair BUT that something is wrong w/ mismatch b/w base (prob w/ what when into formula) 1. Mobile is arguing that if unitary then obligation of Vt to treat as such 2. Stevens dissent: cant just put inc into tax base and not rep in factors, idea that factors follow inc 3. BUT prob how id factors for any particular dividend payment (what yrs earnings and profit, interests, royalties have same prob) e. Fundamental prob left is that factor representation is open issue, get a lot of unfairness b/c states given carte blanc that as long as show unitary can bring in dividends and dont have to give factor 1. ie, ONLY using Mobile USA factors BUT include dividends from foreign subs into tbase 2. Right answer to do what Calif does and treat as combines basis 3. Fairness, internal, external consistency and factors should reflect inc being apportioned 4. Calif ignore sep corp lines, say unitary bus unified by ownership, functionally integrated and ec of scale, so eliminate all inter-co trxn and only trxn w/ 3rd parties matter. One gross receipt minus all costs so get global inc figure and all factors for California totaled (all gas stations) Asarco/Woolworth: same question whether these dividends part of the apportionable tax base at all, basic principle a/f 1980 Mobile: know that form NOT govern and only substantive question whether underlying unitary bus Mobile, Asarco, Woolworth, Container all involved unitary bus question in context whether 2 corp entities engaged in unitary bus if unitary w/ foreign subs, THEN dividends apportionable (Container say question BUT if Calif can req to file on combined basis) Allied Signal peculiar prob, 20.6% invest NOT approp to ask about, the relation b/w 2 cos more appropriate question, whether asset part of unitary bus that asset can form operations/investment function, look at payor/payee unity a. Ct says need integral connection b/w what going on in/out of state Woolworth: makes clear that Norfolk and rest wrong on assumption that RR is RR if one part of bus looks like the other, as matter of substance NOT have centralized mgmt, even though same logo/name, NOT unitary b/c NOT economies of scale, no cent mgmt, not functionally integrated, if there then OK but intensely factual Asarco/Woolworth: discrete bus enterprises, NOT unitary and therefore inc from discrete parts of bus NOT includable in apportionable tbase

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If these cases dont involve unitary bus what is more unitary about rel b/w parent and sub in container? b. Container- ok flow of value b/w parent as subs as long as reas c. Difficult to reconcile Container unitary w/ Asarco/Woolworth that dont and if flow of value is the basis then why NO flow in A and W? d. Std for whether have unitary bus, what Container does to the std if state reas then SCOTUS NOT bother their determination 11. Two ?s: A) whether dividends apportionable, B) whether can req related companies to file as one (Calif.). 12. Mobile: defines unitary bus= functional integration, centralized mgmt and ec of sale i. There is a very slim chance of challenging the three factor test of unitary business the state is in position to say that what its doing is reasonable ii. Can single factor be OK when most all states adopt 3 factor? iii. 3 factor formula (all indicia factors in there) is more reasonable on face than single factor formula where only one factor is sales worst factor for determining realization of income iv. With three factor form taxpayer in difficult position Cant say factors that produce income not reflected in formula because they are and by definition unitary business cant step out different aspects of business (Asarco if dont have unitary business should not be in business of apportionment and NJ had no jxn to tax). v. Norfolk strikes down apportionment (question whether unitary) taxpayer may think if it can show out of proportion with separate accounting might win vi. Moorman strongly reinforces notion that cant impeach with separte accounting UNLESS dramatic demonstration. vii. Exxon and Trinova clear that firmly implant Butler Bros viii. Exxon: focus on question apportionability raise question of fair apportionment and says not withstanding separate accounting evidence simply not enough. The Right To Apportion or Allocate the Tax Base i. Formulary apportionment vs separate geographic accounting separate accounting on geographic basis for whatever going on in the state (Underwood/Butler/Exxon) ii. Does the state look to group of related companies and always treat each company as separate entity (separate company reporting) OR treat as one single combined whole (combined reporting). iii. Question whether treat entities as one or many iv. Vermont separate company reporting and used formulary apportionment Mobile v. Container (Calif) comparing formulary apportionment vs combined reporting using formulary apportionment. vi. Section 4: The State Statutory Framework Governing Division of Corporate Income: The Uniform Division of Income for Tax Purposes Act (UDITPA), pg 596 vii. Introduction a. Two principal constitutional restrains with special relevance to the division of the corporate income tax base

a.

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Unitary business Fair apportionment b. UDITPA type taxing schemes provide rules that attribute the income of a taxpayer whose income is taxable both within and without the state to the various states in which the taxpayer is taxable. viii. Substantive Review a. Start with a companys federal taxable income, and separate into two categories i. Business Income (1a): 9 apportionable apportion by formula (factors) ii. Business Income: income arising form transactions and activity in the regular course of the taxpayers 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 taxpayers regular trade or business operations. iii. once decide this category, it does NOT matter income just goes into the pot iv. Non Business Income (1e): 4 non apportionable then allocated to specific states according to 5-8 v. Non Business Income: all income other than business income vi. NON BUSINESS INCOME MUST HAVE A CONSTITUTIONAL NEXUS vii. Domicile and situs drive where income goes when it is non apportionable viii. 5-8 send non apportionable income to specific state that plausible connection with income aside from income related to business ix. Therefore the real question is whether something is business income or not x. DECISION TREE: Income Business Income (Unitary) Non Business Income (Non Unitary) Therefore apportionable Therefore Allocable Apportionment Factors

i. ii.

Interest

Dividends

Royalties

Review of the Sections 1 Definition of business income, commercial domicile (principal place from which the trade or business of the taxpayer is directed or managed), compensation (wages, salaries, commissions, and any other form of remuneration paid to employee for personal services), Financial organization, non business income, public utility, sales (all gross receipts of the taxpayer not allocated under 4-8), state 2 income taxable both within and without the stae is entitled to use the statute (must have income within and without the state therefore no one shop mom and pop spots) 3 guidelines for determining if taxable in another state

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4-8 Setting out the rules for income that is allocable. 9-17 All business income shall be apportionable. The rest of the sections help set out the 3 factor formula. The Distinction between apportionable and allocable income under state division of income statutes Allocated: income attributed to particular states that considered to be source of income, often on the basis of location of property that gave rise to the income, or taxpayer domicile Apportionment: income divided among various states in which the taxpayer derives apportionable income (3 factor formula) Business/ non business income distinction is different from constitutional apportionable amount when state has an overly expansive definition struck down on Constitutional grounds When it is under inclusive then business income NOT identical to constitutional apportionable income. i. i.e. state can require less than Const limits, but not more. Section 7: The Distinction Between Apportionable And Allocable Income Under State Division of Income Statutes Intro When incomes is allocated it is attributed to the particular state or states that are considered to be the source of the income, often on the basis of the location of the property that gave rise to the income or on the basis of the taxpayers commercial domicile i. When rents, royalties, and capital against from real property are allocated, they are typically allocated in their entirety to the state in which the property is located (5-6) ii. When interest and dividends are allocable they are allocated in their entirety to the taxpayers commercial domicile (7) When income is apportioned it is divided among the various states in which the taxpayer derives such apportionable income i. The mechanism for apportioning income among the state is the three factor formula: Property, payroll, and sale (9). ii. the taxpayers income is attributed to the state on the basis of a percentage determined by averaging g the rations of the taxpayers property. Payroll, and sales within the state, that everywhere (10-17) Division of income begins with the taxpayers federal income base. This, minus allocable income, is apportioned by the formula. Business vs. Non-business Income Distinction Under UDITPA Multistate Tax Code i. MTC: Something is business income if it arises from transactions and activity occurring in the regular course of a trade or business. ii. MTC: All transactions and activities of the taxpayer which are dependent upon or contribute to the operation of the taxpayers economic enterprise as a whole as arising in the regular course of and constituting integral parts of a trade or business. Ex Parte Uniroyal Tire Company, pg 619 i. Facts

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Plaintiff tire company liquidated all its assets, as part of a recapitalization, and realized a capital gain of $ 99.7 million. iii. Plaintiff refused to pay any income tax on the liquidation, arguing that it was nonbusiness income. iv. Defendant, State Department of Revenue, assessed a deficiency, and sued plaintiff for the tax and interest. The lower court upheld the deficiency, and plaintiff appealed the verdict. v. Under the transactional test, the controlling factor by which business income is defined is the nature of the particular transaction giving rise to the income. The frequency and regularity of similar transactions and the former practices of the business are pertinent considerations. vi. A complete liquidation and cessation of business do not generate business income under the transaction test. This is so, because, by definition, such events are most extraordinary; they do not occur in the regular course of the taxpayer's trade or business. vii. "Regular" has been defined as steady or uniform in course, practice, or occurrence: not subject to unexplained or irrational variation: steadily pursued; orderly, methodical; even as returning, recurring, or received at stated, fixed or uniform intervals; functioning at proper intervals. Clearly, the word, "regular" in the phrase "regular course of the taxpayer's trade or business" refers to an ongoing business concern. viii. Held ix. Under state law, plaintiff's liquidation of its assets was not in the regular course of business, and therefore under the Multistate Tax Compact, it was not required to pay tax or interest on the capital gain. Apportionment and Allocation of Income from Real and Tangible Property Apportionment and Allocation of Income from Real and Tangible Personal Property Under UDITPA i. Under UDITPA and similar division of income statutes, allocable income from real and tangible personal property is attributed to the state in which the property is located (5-6) ii. Apportionable income from real and tangible personal property is combined with the taxpayers other apportionable income and apportioned among the states in which the taxpayer carries on the business in which the real or tangible personal property is employed (9) Apportionment and Allocation of Income from Rela and Tangible Personal Property in Non-UDITPA States i. Some states allocate income from real and tangible personal property to the state in which is s located regardless of whether the income from the property arises in transactions in the regular course of the taxpayers trade or business. Apportionment and Allocation of Income from Intangible Property in General The Current Framework i. The line most states currently draw between allocable and apportionable income in their corp income tax regimes in principle makes no distinction between income from intangibles and income from outer sources. Apportionment and Allocation of Interest Income

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Generally i. Allocation only for interest earned on assets that are not part of the taxpayers regular trade or business and they apportion other interest income. Sperry and Hutchinson v. Dept of Rev, pg 637 i. Facts ii. The corporation did business in 48 contiguous states and produced substantial revenues, a large part of which it invested in fixed income securities. iii. The corporation reported the interest received on all three categories as allocable to its domicile rather than apportionable to all states in which it did business. iv. The state claimed that all income received by the corporation as interest on investment securities was apportionable in part to the state. v. The state emphasized that liquidation of the enterprise would have required the corporation to use its long-term investment to redeem outstanding securities. vi. The income from an interstate corporation's long-term investments is not apportionable to the state if neither the capital invested nor the income derived therefrom are a part of the business conducted by the corporation in the state. vii. Any short-term securities held by an interstate corporation to satisfy the needs for liquid capital in the a business within the taxing state are apportionable as these securities are purchased during periods of cash flow surplus and are liquidated when the proceeds, both interest and capital, are needed to meet business obligations during periods of cash flow deficit. Thus, this is business income arising from transactions and activity in the regular course of the taxpayer's trade or business it is part of the unitary business viii. Business Income ix. "Business income" means income arising from transactions and activity in the regular course of a taxpayer's trade or business and includes income from tangible and intangible property if the acquisition, the management, use or rental, and the disposition of the property constitute integral parts of a taxpayer's regular trade or business operations. x. "Non-business income" means all income other than business income. xi. Rents and royalties from real or tangible personal property, capital gains, interest, dividends, or patent or copyright royalties, to the extent that they constitute non-business income, shall be allocated xii. Held xiii. the interest on long-term and short-term securities held by the corporation for investment was not apportionable, xiv. but that the interest on short-term securities used in the corporation's business was apportionable. Apportionment and Allocation of Dividend Income Generally i. Most states exclude some or all dividends from the net income measure of their corporate taxes.

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Under UDITPA and similar statutes dividends (like interest) are apportioned if they constitute business income and allocated to the taxpayers commercial domicile if they constitute non-business income. Allocation of Dividends to the Commercial Domicile i. The rationale behind the allocation of dividends to the state of the recipients commercial domicile rests squarely on the residence principle of taxation. ii. The justification for allocation a corporations intangible income to its commercial domicile is simply the application of the established doctrine that a state may tax its residents on their income without regard to its source. Apportionment and Allocation of Capital Gains and Losses The rule for apportioning and allocating capital gains and losses from sales of intangible personal property are essentially the same as rules applicable to dividends. Section 8: The Apportionment Formula: Delineation of the Factors Generally Movement away from equally weighted factors, lots of states adopting single factor more economic dev tax NOT really inc tax Justifications for factors below, ought to relate to inc Some const limits on states, their choice on # factors and which factors, Moorman- states DO NOT have to use similar formulas and up to them what formula they use i. Issues in construction of prop and payroll factor, sales MOST controversial factor, least justified factor and MOST important as states move to exclusive sales factor (Iowa) or weight more heavily for dev purposes (more dollars assoc w/ sales factor) Property Factor usually only includes real and tangible personal property. State of Alaska Dept of Rev v. Amoco, pg 649 i. Background ii. Amoco contends that the value of its leaseholds in Alaska that are not producing oil or gas should not have been included in the apportionment formulas property factor iii. If a taxpayer's gross income is derived from sources both inside and outside the state and the part inside is so separate and distinct from and unconnected with the part outside that the net income from the part inside can be determined without regard to the part outside, then the part outside the state shall not be considered in computing the income tax iv. Alaska Statute: v. All business income which cannot be directly apportioned and allocated to this state shall be apportioned to this state 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 which is three. vi. The property factor is a fraction, the numerator of which is the average value of the taxpayer's real and tangible personal property owned or rented and used in this state during the tax period and the denominator of which is the average value of all the taxpayer's real and tangible personal property owned or rented and used during the tax period.

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The numerator of the property factor shall include the average value of the taxpayer's real and tangible personal property in this state during the tax period used, is available for use, or is capable of being used for the production of business income. The United States Constitution does not invalidate an apportionment formula whenever it may result in taxation of some income that did not have its source in the taxing state. Nevertheless, the court will strike down the application of an apportionment formula if the taxpayer can prove by clear and cogent evidence that the income attributed to the state is in fact out of all appropriate proportions to the business transacted in that state, or has led to a grossly distorted result. Held the non producing leases were properly included in the property factor under the statute and that such inclusion IS constitutional Notes Rented Property in the Property Factor a. The value of rented property is usually determined by a multiple of net rents (gross rents paid less rents received on sub-rentals of the property), almost always at eight times rentals.

Payroll Factor Generally

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Payroll attributed to the taxable state if the services are performed entirely within the state or the services are performed both within and without the state and a. the service performed without the state is incidental to the service performed within the state b. the base of operations or if there is none, the place from which the service is director or controlled is in the state or c. the base of operations is not in any state in which the employee performs services but his residence is in the state. iv. Wherever the W-2 goes. Cincinnati v. Ky Dept of Rev, pg 656 i. Facts ii. The Kentucky Department of Revenue (department) audited the taxpayers, a railway company and its subsidiary, and found that they owed additional taxes. iii. The taxpayer's appealed and the board of tax appeals (board) entered an order favorable to them. The department appealed that decision, and the trial court reversed the board's decision. iv. The trial court entered judgment against the taxpayers once again. v. Upon the taxpayers' subsequent appeal, the court reversed and remanded the portion of the trial court's order that denied the subsidiary from including in its apportionment formula the compensation paid to the railway corporation for use of its employees. vi. It also subtracted from the taxpayers' deductions the percentage of non-business income rather than the actual expense.

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The court found that the subsidiary indirectly compensated the employees whose activities they controlled when the employees performed services for them. viii. Because the railway company did not profit from loaning their employees to the subsidiary, the subsidiary was the employer of the railway company's employees when they performed services for the subsidiary. ix. To include compensation of employees in the formula of a company for whom service was performed would promote this purpose. The payroll factor is determined by comparing the "compensation" paid in Kentucky and the total "compensation" paid. Statute defines compensation as follows: wages, salaries, commissions, and any other form of remuneration paid or payable to employees for personal service. x. The expense to produce non-taxable income cannot be deducted from taxable income. xi. Held xii. denied the subsidiary from including in its apportionment formula the compensation paid to the railway corporation for use of its employees and subtracting from the taxpayers' deductions the percentage of nonbusiness income rather than the actual expense. Receipts or Sales Factor Generally i. Historically the states used four different methods for attributing receipts to the numerator of a states sales factor ii. the destination test attribution to the state in which the goods are shipped to the customer or in which they are delivered to the customer iii. the origin test - attribution to the state of the factory, warehouse, or office from which the goods are shipped iv. the sales office negotiation test attribution to the state of the sales office from or through which the sale was principally negotiated v. the sales activity test attribution to the state in which the sales employees principally conducted selling activities. vi. The sales factor has become the most heavily weighted factor now. vii. UDITPA viii. 16: sales of tangible personal property are in this state if a. The property is delivered or shipped to a purchaser other htan the govt within this state regardless of the fob point or other conditions of the sale or b. The property is shipped from an office store warehouse, factory or other place of storage in this state and i. The purchaser is the US govt ii. Or the taxpayer is NOT taxable in the state of purchaser. ix. 17: Sales other than sales of tangible personal property are in this state if a. The income producing activity is performed oin this state b. Or the income producing activity is performed both in and outside this state and a greater proportion of the income producing

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activity is performed in this state than in any other state based on costs of performance. Two Sales Factor Issues i. Sales of tangible personal property ii. Issues construing sales factor for non merchant/ non manufacturing industries. Commonwealth of Pa v. Gilmour, pg 659 i. Facts ii. The manufacturer made its products at a facility in Pennsylvania, and sold them throughout the United States, most often shipping them to outof-state purchasers through common carriers. iii. Some of the out-of-state customers preferred to retrieve the products themselves at the manufacturer's Pennsylvania loading dock. iv. The manufacturer referred to these customer pick-up transactions as dock sales, for which it provided a freight allowance to its customers. v. The manufacturer excluded its dock sales to out-of-state purchasers from its calculation of its corporate net income tax. vi. The Pennsylvania Department of Revenue, however, disagreed with the manufacturer's calculations, and included as sales in Pennsylvania the dock sales where out-of-state purchasers retrieved the goods themselves. vii. This resulted in an increase in the manufacturer's tax due. viii. Pa Statute states, as the general rule, that sales of tangible personal property are in the state in which delivery to a purchaser occurs. ix. Viewing the plain language of the statute in a common sense fashion, as a matter of basic sentence construction, the phrase "within this State" is intended to modify the immediately preceding word "purchaser." x. Longstanding case law suggests that delivery to a common carrier is tantamount to delivery to the purchaser. It would appear that, under Pennsylvania law, no valid distinction exists between dock sales to out-ofstate purchasers and sales to out-of-state purchasers shipped by common carrier. xi. Mere administrative ease cannot justify a regulation which is inconsistent with the language and purpose of a statute. xii. Held xiii. Department's regulation was contrary to the clear wording the statute. xiv. Accordingly, the dock sales to out-of-state customers did not count towards the manufacturer's corporate net income tax. xv. Upshot xvi. Penn cannot tax dock sales to out of state purchasers who come and pick up rather than receiving delivery in their state xvii. To a purchaser who is not w/ in Pa NOT sale in the state WILL NOT be too difficult as claimed by the state b/c the burden rests on the entity to show w/ shipping records that the tpp was taken outside PA for resale in another jxn xviii. most courts construing UDITPA and similar statutes have likewise concluded that dock sales to out of state purchasers are NOT in state sales. Throwback and Throwout Rules

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Throwback Rule In order to prevent any part of the tax base from being assigned to states in which the taxpayer is not taxable and this from escaping taxation there is a throwback rule iii. Under the throwback rule sales into states in which the taxpayer is not taxable (Public Law 86-272) are reassigned from the state of destination to the state of origin (16a) iv. Throwout Rule v. provides an alternative to the throwback rule. vi. receipts otherwise assigned to a state in which the taxpayer is not taxable are thrown out of both the numerator and denominator of the sales factor. Receipts from Sales the Basic Rule i. The receipts factors of the state apportionment provisions typically include receipts from thee rendition of services. ii. UDITPA does not cover receipts from services. iii. therefore receipts from services are dealt with as sales of other than tangible personal property. iv. The problem arises because as far as attributing to states, it is all or nothing. BOSTON BRUINS CASE???

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Corporate Income, Franchise, and Capital Stock Taxes. Corporate Stock Taxes. Measures employed fall into two general classifications: Capital Account Bases. Either authorized shares or outstanding (issued) shares, generally valued at par value and at various arbitrary amounts in the case of no-par shares. a. See page 433-34 of book if need to write on this. Capital-Value Bases. Defined in terms of balance sheet valuation with some adjustments for more realistic valuation. (May be valued by corporations net value or shares market value.) Corporate Income Taxes. Allocation. Allocation attempts to trace the property, income, or receipt to the state of its source and to include the item in full in the measure of that states tax. Apportionment. a. One factor test. Where take value of all of Ts real and person property and see how much of a percentage of it is taking place in your state, taxing that amount. (While some states still use this for apportioning capital stock, generally have discarded it when apportioning income.) (Ct presumes it is valid under Underwood.) b. Three factor test. Real and tangible personal property, payroll, and sales. Historically, the three factors were averaged, so that if a corporation had 40% of its property, 35 percent of its payroll and 15 percent of its sales in the state, its apportionment percentage would be 30 ([40+35+15] /3); and it would apportion 30 percent of its income or capital stock or other measure of the tax to the state. Today, roughly half the states put additional weight (usually

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double) on the sales factor, so that the corporation described in the preceding sentence would have an apportionment factor of approximately 26 percent ([40 + 35 +15 + 15]/4). Separate Accounting. The separate accounting method is generally limited to the division of income as distinguished from other tax bases of the multistate business. The essential problem with separate accounting, as the U.S. Supreme Court has observed, is that separate accounting, while it purports to isolate portions of income received in various States, may fail to account for contributions to income resulting from functional integration, centralization of management and economies of scale. Apportionability and Fair Apportionment. Since much of the taxpayers property, income or receipts may be located outside the state in a territorial sense, the question becomes whether the state is justified in looking to such out-of-state property, income, or receipts for purposes of determining the property, income or receipts that are taxable by the state. The answer to this question depends largely on whether the property, income, or receipts derive from the unitary business that the taxpayer carries on within the taxing state. a. The second problem is to determine the actual percentage of the tax base that should be apportioned to the state. If the taxpayer can demonstrate that the property, or income, or receipts assigned to the state by formula bear no reasonable relationship to the taxpayers local presence or activities, the Due Process and Commerce Clauses will bar the state from taxing the tax base assigned to the state by formula. b. Finally, you should be aware that these two questions---(1) what is the apportionable tax base? and (2) is the apportionment fair?--- are not always clearly articulated or differentiated in the judicial opinions, even though they are analytically distinct. Apportionment by Formula in general - Federal Constitutional Limitations. Apportionable Tax Base: a. Functional Integration as Req of Unitary business. In Exxon Corp, the Court began to give content to the dichotomy between a unitary business and unrelated business activity which constitutes a discrete business enterprise, it explored the meaning of the functional integration requirement. i. In Exxon, a wholly owned subsidiary of Exxon engaged in all aspects of the petroleum business. The only business that it carried on in Wisconsin was the marketing of petroleum products and accessories. The company filed its returns under Wisconsin's net income tax on a separate accounting basis, which showed annual net losses in Wisconsin for the four years at issue. The linchpin of apportionability for state taxation of an interstate enterprise is the unitary business principle, whereby if an entity is a unitary business, the state may apply an apportionment formula to the taxpayer's total income in order to obtain a rough approximation of the income that is reasonably related to the activities conducted within the taxing state. In order to exclude certain income from the apportionment formula, the entity must prove that the income was earned in the course of activities unrelated to activities

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conducted within the taxing state, and in such regard, a court will look to the underlying economic realities of a unitary business and require that the income sought to be excluded from apportionment be derived from unrelated business activity which constitutes a discrete business enterprise. a. Wisconsin Supreme Court test for unitary business. "Whether or not the operation of the portion of the business within the state is dependent upon or contributory to the operation of the business outside the state. ii. Exxon had made much of the fact that the gasoline it sold in Wisconsin was not manufactured in Exxon refineries in other states. Ct apparently treated the exchange agreement as dependent on Exxon's production and manufacture, in states other than Wisconsin, of gasoline that it was able to provide Pure Oil Company on the exchange. Hence, the marketing of gasoline by Exxon in Wisconsin was linked to Exxon's out-of-state exploration, production, refining, and manufacturing. iii. On the basis of these factors, which revealed as functionally integrated a business as one is likely to find, the Court had little difficulty concluding that the evidence fully supports the conclusion that appellant's marketing operation in Wisconsin is an integral part of a unitary business. Allied-Signal involved the question whether New Jersey could tax a share of the gain that a Michigan-based manufacturing corporation (Bendix) realized from the sale of its 20.6 percent investment in an unrelated metal mining corporation (ASARCO). While acknowledging that its precedents gave the states wide latitude in fashioning formulas designed to attribute the in-state portion of the value generated by a corporation's multistate activity, the Court noted that this was a far cry from New Jersey's theory that any business in the State, no matter how small or unprofitable, subjects all of a corporation's outof-state income, no matter how discrete, to apportionment. i. The Court properly repudiated the suggestion in ASARCO and Woolworth that income from intangibles is not apportionable unless the payor is engaged in a unitary business with the payee. ii. The adoption of an apportionability standard based on whether the intangible asset serves an operational function. The Court articulated the governing standard for determining whether income from intangibles is apportionable: What is required is that the capital transaction serves an operational rather than an investment function. Focuses on the assets use and its relation to the TPs activities within the taxing State. a. The content that the Court gave to this criterion, however, is less than clear, although it need not have been. In principle, the operational-function criterion is one which focuses on the objective characteristics of the asset's use and its relation to the taxpayer and its activities within the taxing State. Income from working capital

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capital currently used in business operationsis the paradigm of apportionable income under this view, and the Court explicitly adverted to such income in delineating the operational-function standard. Likewise so-called Corn Products income from intangible assets used in the present conduct of the business (e.g., commodity futures acquired to secure a source of supply at a foreseeable price) plainly satisfies the operational-function test thus defined. b. In elaborating upon the definition of assets that serve an operational function, it declared: [I]n ASARCO, although we rejected the dissent's factual contention that the stock investments there constituted interim uses of idle funds accumulated for the future operation of [the taxpayer's] business [operation], we did not dispute the suggestion that had that been so the income would have been apportionable. c. The Court's gratuitous remark has created theoretical confusion by loosing the asset-use test from its moorings in the present operations of the taxpayer's business. The critical question for determining whether income from an asset is apportionable ought to be whether there is an organic connection between the asset and the taxpayer's existing business activity in the state. By relaxing the operationally connected standard to include assets that are not serving the current needs of the business but will serve it in the future, the Court severed this essential link. Under the idle-funds-accumulated-for-future-use-in-thebusiness standard, the purpose for which the funds are being heldrather than any organic connection to the business becomes the touchstone of apportionability. Yet it was that very business purpose standard that the Court rejected in ASARCO and Woolworth and, indeed, in Allied-Signal itself. In its comparison of Bendix's investment in ASARCO with investments in intangibles that would satisfy the operationalfunction criterion, the Court appears to emphasize the shortterm character of an investment as affecting the question whether it serves an operational function or an investment function. While it may be true as a practical matter that intangible assets used for working capital are generally short-term, highly liquid investments, whereas intangible assets held in anticipation of future business opportunities tend to be of longer duration, there is nothing about the term of the investment that in itself makes it operational or nonoperational. In short, the Court's references to the term of the investment are best viewed as making an empirical rather than a substantive observation acc. to Hellerstein.

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Hunt-Wesson. The court found that the offset provision of the state tax law in using nonunitary dividend and interest income to offset TPs expense deductions was not a reasonable allocation of expense deductions to the income that the expense generated, and was an impermissible taxation of income outside the state's jurisdictional reach. (Normally, might be able to argue that TP is borrowing to support nonunitary operations, but here, cannot do so.) d. MeadWestVaco (2008). our references to operational function in Container Corp. and Allied-Signal were not intended to modify the unitary business principle by adding a new ground for apportionment. The concept of operational function simply recognizes that an asset can be part of a taxpayer's unitary business even if what we may term a unitary relationship does not exist between the payor and payee. e. the importantbut narrowholding of MeadWestvaco is that one does not inquire into enterprise unity under both the traditional unitary factors first articulated in Mobil and again under the operational-function test. The lower court erred by revisiting the question of enterprise unity under the operational-function theory after it had already resolved the question under the traditional (and appropriate) enterprise criteria.. Apportionment by Formula in general - Federal Constitutional Limitations. Fair Apportionment: a. Moorman. Supreme Court repudiated the constitutional overtones of General Motors in sustaining Iowa's single-factor sales formula when TP claimed it was unconstitutional as it resulted in double taxation as most other states had the three factor test. i. In response to the taxpayer's contention that the tax violated the Due Process Clause in that it allegedly taxed profits generated in Illinois, the Court relied on the taxpayer's failure to carry its burden of proof, something that has been overcome only once. ii. First, Moorman had failed to establish the essential factual predicate for a claim of duplicative taxation: the company had not proven that Illinois and Iowa together imposed a tax on more than 100% of the relevant net income. Second, despite this flaw in the taxpayer's case, even were we to assume that the Illinois activities made some contribution to the profitability of the Iowa sales, appellant's claim that the Constitution invalidates an apportionment formula whenever it may result in taxation of some income that did not have its source in the taxing State is incorrect. Said constitution does not prohibit multiple taxation and Congresss role, therefore, to mandate uniform formula. iii. In a sense, the Ct just said that Iowas statute was internally consistent. b. Ott v. Mississippi Barge Line, (US 1949). The problem under the Commerce Clause is to determine what portion of an interstate organism may appropriately be attributed to each of the various States in which it functions. So far as due process is concerned, the only question is whether the tax in practical operation has relation to opportunities, benefits, or protection

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conferred or afforded by the taxing State. Those requirements are satisfied if the tax is fairly apportioned to the commerce carried on within the State. c. As a matter of logic, however, a question that should be resolved before a court addresses the fairness of the application of an apportionment formula is whether the formula is fair on its face. Indeed, as a theoretical matter, the Court has insisted that an apportionment formula not be inherently or intrinsically arbitrary. This means, among other things, 1) that the formula must possess internal consistencythat is, the formula must be such that, if applied by every jurisdiction, it would result in no more than all of the unitary business income being taxed. It also means 2) that the factor or factors used in the apportionment formula must actually reflect a reasonable sense of how income is generated. i. But the Court has never held an apportionment formula unconstitutional on its face. Despite the fact that the Court has never held an apportionment formula unconstitutional on its face, a formula incompatible with the foregoing theoretical norms should not survive constitutional scrutiny. Apportionment by formula as applied to multicorporate enterprises: Federal Const Limitations. a. Mobil. The wrinkle in the case, however, and the one that makes it relevant to the apportionability of income from intangibles, is that Mobil was conducting much of that businessparticularly in foreign countriesthrough wholly and partly owned subsidiaries and affiliates. If had done so via divisions, there would have been no question. Mobil contended that the requisite link between its activities in Vermont and the intangible income that Vermont sought to include in its apportionable tax base was missing because all of its activities relating to its stock holdings in these corporations, including the receipt and management of the dividends themselves, occurred outside of Vermont at its commercial domicile in New York. If Vermont wanted to rely on the unitary relationship between Mobil and its subsidiaries as a basis for including the income generated by such subsidiaries in Mobil's apportionable tax base, then, according to Mobil, Vermont should have treated Mobil and its subsidiaries as a single unitary enterprise by combining the operating income of Mobil and its subsidiaries and apportioning this income on the basis of the combined property, payroll, and sales factors of the unitary corporate group. i. One must look principally at the underlying activity, not at the form of investment, to determine the propriety of apportionability. ii. the linchpin of apportionability in the field of state income taxation is the unitary business principle iii. So long as dividends from subsidiaries and affiliates reflect profits derived from a functionally integrated enterprise, those dividends are income to the parent earned in a unitary business. One must look principally at the underlying activity, not at the form of investment, to determine the propriety of apportionability. a. Transforming the same income into dividends from legally separate entities works no change in the

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underlying economic realities of a unitary business, and accordingly it ought not to affect the apportionability of income the parent receives. The multicorporate form of a business would not by itself shield income distributed as dividends from state taxation if such income was derived from a unitary business. b. Where the business activities of the dividend payor have nothing to do with the activities of the recipient in the taxing State, due process considerations might well preclude apportionability, because there would be no underlying unitary business. c. (Ct has noted that separate accounting, while it purports to isolate portions of income received in various states, may fail to account for contributions to income resulting from unitary business factors: functional integration, centralization of management, and economies of scale.) d. What appellant must what appellant must show, in order to establish that its dividend income is not subject to an apportioned tax in Vermont, is that the income was earned in the course of activities unrelated to the sale of petroleum products in that State. e. So long as dividends from subsidiaries and affiliates reflect profits derived from a functionally integrated enterprise, those dividends are income to the parent earned in a unitary business. One must look principally at the underlying activity, not at the form of investment, to determine the propriety of apportionability. f. Allocation. The Court also has recognized that "the reason for a single place of taxation no longer obtains" when the taxpayer's activities with respect to the intangible property involve relations with more than one jurisdiction. Moreover, cases upholding allocation to a single situs for property tax purposes have distinguished income tax situations where the apportionment principle prevails. The reasons for allocation to a single situs that often apply in the case of property taxation carry little force in the present context. Centralized Management and Control as a Requirement of a Unitary Business. ASARCO. Involved corporation also claiming that it should not be taxed on dividends it received from subsidiaries. Held that ASARCO did not control subsidiary within meaning of that term, so insufficiently connected to parent to be taxed. i. The Court reaffirmed the principle that the exercise of actual control of a subsidiary, as distinguished from the legal right to control the company, is a prerequisite of a unitary business relationship. The Court also observed that M.I.M. operated

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entirely independently of and ha[d] minimal contact with ASARCO and sold ASARCO only one percent of its output. ii. Container Corporation. The Court pointed to a number of managerial links to support its conclusion that Container was carrying on a unitary business with its subsidiaries, including the fact that [h]igh officials of appellant gave directions to subsidiaries for compliance with the parent's standard of professionalism, profitability, and ethical practices; the considerable interplay between appellant and its foreign subsidiaries in the area of corporate expansion; and the supervisory role played by appellant's officers in providing general guidance to the subsidiaries iii. In Exxon, the Court pointed to the advantages that Exxon enjoyed as a result of the economies of scale from centralized purchasing and other advantages that accrued from its umbrella of...controlled interaction. By contrast, inASARCO and Woolworth, there was little evidence of economies of scale because there was virtually no centralized purchasing, exchange of personnel, or centralized management. In Container, on the other hand, the Court found that the parent assisted its subsidiaries in obtaining used and new equipment and in filling personnel needs that could not be met locally, thus suggesting that the group of controlled corporations enjoyed economies of scale. In Container, the Court also observed that when a corporation invests in a subsidiary that engages in the same line of work as itself, it becomes much more likely that one function of the investment is to make better use either through economies of scale or through operational integration or sharing of resources of the parent's existing business related resources. iv. SEE TREATISE PAPERS WORLDWIDE APPORTIONMENT OF THE INCOME OF MULTICORPORATE UNITARY BUSINESS: THE BARCLAYS CASE. a. Impairment by Worldwide Apportionment of Federal Uniformity in Areas Where It Is Essential. The Court enumerated various facts that weigh strongly against the conclusion that the tax imposed by California might justifiably lead to significant foreign retaliation: i. The tax does not create automatic asymmetry. ii. Container can clearly be taxed by California, so the amount of its tax is more a function of rate than allocation iii. there were no specific indications of congressional intent to preempt California's tax. b. Intl Multiple Taxation in Barclays. i. The enhanced risk of multiple taxation. The Court observed that Container's holding rejecting the taxpayer's multiple taxation argument rested on two considerations: a. First, the multiple taxation in Container though real was not inevitabl[e], because it resulted from the overlap of two different methods of dividing a tax base and could as easily result in undertaxation as in overtaxation.

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Second, the alternative method available to the taxing state (arm's-length, separate accounting) would not eliminate the risks of multiple taxation because different jurisdictions apply the arm's-length separate accounting method differently. THE DISTINCTION BETWEEN ALLOCABLE AND APPORTIONABLE INCOME UNDER STATE DIVISION-OF-INCOME STATUTES When income is allocated, it is attributed to the particular state or states that are considered to be the source of the income, often on the basis of the location of the property that gave rise to the income or on the basis of the taxpayer's commercial domicile. i. For example, when rents, royalties, and capital gains from real property are allocated, they are typically allocated in their entirety to the state in which the property is located. When interest and dividends are allocable, they are allocated in their entirety to the taxpayer's commercial domicile. When income is apportioned, on the other hand, it is divided among the various states in which the taxpayer derives such apportionable income. The mechanism for apportioning income among the states under UDITPA is the familiar three-factor apportionment formula of property, payroll, and sales. i. Under this formula, a taxpayer's income is attributed to the state on the basis of a percentage determined by averaging the ratios of the taxpayer's property, payroll, and sales within the state to its property, payroll, and sales everywhere. The division of income process usually begins with the taxpayer's federal income tax base (federal taxable income). i. The statutes typically require that specific categories of income be allocated to a single state or, occasionally, to several states. The balance of the taxpayer's income (i.e., the federal taxable income less allocable income) is apportioned among the states by formula. a. Under UDITPA and similar taxing regimes, the determination whether a taxpayer's income is allocated or is apportioned depends on the question whether the income is determined to be business income or nonbusiness income. i. Under UDITPA and similar taxing regimes, all business income is apportioned; all nonbusiness income is allocated a. UDIPTA Defines Business Income. Business income means income arising from transactions and activity in the regular course of the taxpayer's trade or business and includes income from tangible or intangible property if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations 1. Some interpret second prong to be functional test, while others say only transactional test is visible. b. UDITPA further provides: Nonbusiness income means all income other than business income. c. The regulations issued by the Multistate Tax Commission (MTC) provide: "Income of any type or class and from any source is business income if it arises from

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transactions and activity occurring in the regular course of a trade or business....In general all transactions and activities of the taxpayer which are dependent upon or contribute to the operations of the taxpayer's economic enterprise as a whole constitute the taxpayer's trade or business and will be transactions and activity arising in the regular course of, and will constitute integral parts of, a trade or business. d. The MTC regulations construe UDITPA as establishing a presumption in favor of apportionment, for they state that the income of the taxpayer is business income unless clearly classifiable as nonbusiness income. Many UDIPTA states have adopted the MTC regulations, but you must examine each state's regs to ascertain the extent to which the MTC regulations are applicable in a particular state. UDITPA's definition of business income does not differ markedly from the constitutional definition of apportionable income. It is, in substance, just one of the many variations on the definition of a unitary business, which the Court in Container acknowledged was not unitary. Indeed, the Court in Allied-Signal, declared that UDITPA's definitions of business and nonbusiness income [i]n the abstract...may be quite compatible with the unitary business principle. Moreover, some state courts draw no distinction between the statutory definition of business income and the constitutional definition of unitary business income in determining the question of apportionability. Nevertheless, the fact that UDITPA's business income definition may, in the abstract, be consistent with the U.S. Supreme Court's delineation of the unitary business principle in constitutional terms does not mean that the application of that definition in judicial decisions or in the MTC regulations will comport with the constitutional definition of a unitary business. Indeed, one need look no further than ASARCO and Woolworth, both of which construed UDITPA's business income definition, to know that the abstract compatibility of UDITPA's business income definition with the constitutional definition of a unitary business tells us little about the compatibility of the application of that definition with constitutional restraints. While UDITPA's business income definition is thus confined by federal constitutional restraints on apportionability, there is no requirement that UDITPA's business income definition extend as far as the Constitution permits. Indeed, the controversy over the question whether the business income definition includes a functional test or is limited to a transactional test is not a debate that is seriously influenced by federal constitutional restraints. Both definitions are constitutionally acceptable (in the abstract). Income satisfying the functional test would ordinarily be apportionable as a matter of federal constitutional law because it derives from the disposition of an asset that is operationally connected to the taxpayer's trade or business. The critical issue is whether the statute reaches such constitutionally apportionable income.

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Ex Parte Uniroyal Tire Company(2000). The Alabama Supreme Court concluded that the business income definition contains only a transactional test, despite a state regulation adopting the functional test. The court therefore held that a corporation's gain from the liquidating disposition of a partnership interest constituted nonbusiness income. (Under this view, gain from the sale of assets, even if used in the business, does not constitute business income if the transaction triggering the gain does not arise in the regular course of the taxpayer's trade or business. Income from unusual or extraordinary transactions is therefore allocable rather than apportionable under the transactional test.) e. Uniroyal sold its entire partnership interest for approx 260M and realized a capital gain, which Uniroyal declared as nonbusiness income. f. Hellerstein tells us that those states that use UDIPTA use the functional test. Alabama quickly amended the legislation adopting the functional test, overruling the case of Uniroyal. g. Other states may use a rule that says why have distinction between business income and nonbusiness income, have instead that all business income is apportioned and business income is apportionable and is the maximum amount we can tax under the constitution. h. When states adopt the functional test, it renders the first paragraph of UDIPTA superfluous. Courts are supposed to give each word and phrase meaning, but it you cannot, you cannot. i. Do you think the state of Alabama could have constitutionally taxed all income permitted by the constitution? Allied Signal said state could take apportionable share of all income of unitary business. Is this part of a unitary business? This was the whole business. Functional and transactional test are not part of the constitutional requirement and constitution can be broader and include liquidations, even if not within functional test. (Additionally, this company is really like an investment company.) ALLOCATION AND APPORTIONMENT OF INCOME FROM REAL AND TANGIBLE PERSONAL PROPERTY i. Under UDITPA and similar division-of-income statutes, a. nonbusiness income from real and tangible personal property is allocated to the state in which the property is located. b. Business income from real and tangible personal property is combined with the taxpayer's other business income and apportioned among the states in which the taxpayer carries on the business in which the real or tangible personal property is employed. ii. Under non-UDIPTA States: a. While most states have statutes that draw the line between apportionable and allocable income on the basis of UDITPA's business income definition or on a definition of apportionable income that is substantially equivalent to UDITPA's business income definition, some states allocate income from real and tangible personal property to the state in which it is located regardless of whether the income from the property arises in transactions in the regular course of the taxpayer's trade or business. In Oklahoma, income from mineral leases, royalty interests, oil payments, or other mineral interests is attributed to the state where the mineral property is located. In Louisiana, rents

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and royalties from real and tangible personal property are allocated directly to the state or states where the property is located. ALLOCATION AND APPORTIONMENT OF INCOME FROM INTANGIBLESIN GENERAL i. Capital Gain. Under UDIPTA, if you have nonbusiness capital gain, then you allocate to place of commercial domicile. Outside UDIPTA, some states do not care about distinction between business and nonbusiness income, so allocate to place of commercial domicile. Some states try to allocate. ii. Thus nonbusiness interest, dividends, and capital gains from the sale of intangible property are allocated to the taxpayer's commercial domicile. Nonbusiness patent and copyright royalties, on the other hand, are allocable to the state in which the patent or copyright is utilized by the royalty payor, unless the taxpayer is not taxable in such state, in which case the royalties are allocated to the taxpayer's commercial domicile. ALLOCATION AND APPORTIONMENT OF INTEREST i. Most states, under UDITPA and similar statutes, allocate only interest earned on assets that are not part of the taxpayer's regular trade or business, and they apportion other interest income. a. In Sperry & Hutchinson Co. v. Department of Revenue, facts, the taxpayer was a New Jersey corporation, whose commercial domicile was in New York. Sperry & Hutchinson's (S&H's) primary business, and the only business it conducted in Oregon, was the sale of green stamps as a promotional service to retailers. During the years in question, the business was very profitable, and S&H invested a large part of its excess funds in fixed income securities, divided into three categories: (1) short-term securities held pending use of the funds in the green stamp business; (2) short-term securities held pending acquisition of other companies or favorable developments in the long-term money market; and (3) long-term securities held as an investment. i. The Oregon Department of Revenue determined that the interest from all three categories of securities constituted business income subject to apportionment. ii. Reasoning. The income from S&H's long-term investments are not apportionable to Oregon because neither the capital invested nor the income derived therefrom is a part of the trading stamp business conducted in this state. iii. Holding. We hold that because S&H's long-term investment income was neither closely connected or necessary under the old statute, nor income arising from transactions...in the regular course of the taxpayer's trading stamp business under the new statute, the interest is not apportionable. Therefore, 1) the interest on the long-term and short-term securities held for investment was allocable nonbusiness income. At the same time, 2) the court concluded that the income derived from short-term securities held to satisfy the needs for liquid capital in the stamp business constituted business income and was therefore apportionable. b. Other courts construing UDITPA have followed Sperry & Hutchinson when confronted with the question whether interest income is

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apportionable or allocable. For example, the Colorado Supreme Court followed Sperry & Hutchinson in holding that interest income on short-term loans made to the taxpayer's parent company, out of surplus funds not immediately needed for current operations, constituted business income. The Kentucky Court of Appeals adopted a similar view in holding that the income that railroad companies received from short-term securities purchased with revenue from their railroad business constituted business income. To the railroads' argument that they were in the railroad business, not in the securities business, the court responded that the statute does not limit business income to income from the taxpayers' trade and that the railroads' investments are an integral part of their regular business operation. The South Carolina apportionment statute provides that [i]nterest received by the taxpayer from intangible property not connected with the taxpayer's business shall be allocated. The South Carolina Court of Appeals declared that the question whether interest income is apportionable or allocable depends not upon whether the income in dispute is connected with the business of the taxpayer, but rather whether the property producing the income is connected with the business. i. Under this standard, the court held that interest income on loans of excess funds by a subsidiary to its parent was apportionable because the following factors established a broadbased connection between the notes representing the loans and the subsidiary's business: (1) the funds loaned to the parent originated from and were generated by the business of the subsidiary; (2) the interest income produced by the notes, as well as the repayment of the notes themselves, were used for the subsidiary's normal business operations; (3) the notes were created on a daily basis; (4) the subsidiary required repayment of the notes when it needed cash for business purposes; and (5) the notes were demand notes. Although the Minnesota Legislature has amended the state's division-of-income statutes on numerous occasions over the years, the current statute reflects the long-standing rule in that state that all income that is derived from a trade or business being carried on in the state is apportionable. In Montgomery Ward & Company, whose commercial domicile was located outside the state and which had accumulated some $300 million in cash out of the earnings of its nationwide general merchandise business in anticipation of a change in the economic climate which would make expansion of the business operation profitable. Pending this development, the taxpayer invested the funds outside Minnesota in liquid securities, and it did not segregate the funds from its other current operating income. The statute provided: " trade or business...carried on partly within and partly without this state. In sustaining the Tax Commissioner's inclusion of the income from the securities in the apportionable tax base, the court employed the unitary business principle in determining whether the securities constituted intangible property employed in the interstate business. i. Montgomery Ward's major contention was that the income, gain, and principal of the securities at issue were not used to pay the expenses and obligations of the business activities, but

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instead the primary purpose for which it acquired the intangibles was theexpansion of its business. The court referred to the facts that the taxpayer carried the intangibles on the corporate balance sheet as current assets and that it commingled the income from the investments with other corporate business income in accounts used to pay ordinary business obligations. The court concluded that the taxpayer had failed to sustain its burden of proving that the intangibles were not employed in its principal business. The court evidently regarded the income in controversy as on the borderline between apportionable and nonapportionable income, because it remanded the case to give the taxpayer an opportunity to show that for all practical purposes some part of the amounts up to $300,000,000 held during the period in question and invested in liquid securities was not actually used or usable in its merchandising operation in any significant sense. ALLOCATION AND APPORTIONMENT OF DIVIDENDS Can be apportioned acc to Exxon case. UDIPTA says that nonbusiness income is not apportionable, and if business income, then apportionable. a. MTC (Multistate tax commission) has reg on this. b. Reason for allocation is state of residence can tax all income without regard to source, except insofar as states ability to tax is restricted by other states power to tax under source based principles. Hellerstein notes that generally, these allocation rules of UDIPTA rely on states computation of income, putting back some things taken out for federal tax purposes. If apple is doing a bit of business income in NY. Sup Ct has not ruled on this issue, but e/b assumes they would find no problem as internally consistent and externally consistent. Most of the states exclude some or all dividends from the net income measure of their corp taxes. Mobil made clear though that dividend could be apportioned to state if it meets operational test. Accordingly, dividends from temp investments of working capital or other current funds held for normal operating used and dividends received from stocks falling within the corn Products doctrine are plainly apportionable, even if the paor of the dividends is not unitary with the payee. Patents and Copyrights. If GM and have all these patents and somehow, an employee dies that owns a copyright to baseball and leaves it to GM. That is usually allocated to state where the payor used the intangible. In the Geoffrey case, if had baseball card and licensed it in NC, then that is where allocate income to. Have to ask where the money for the copyright is coming from. Most states no longer follow such rules. Rather they allocate royalties to the state of use. Thus under UDITPA, patent and copyright royalties, to the extent that they constitute nonbusiness income, are allocated to the state if and to the extent that the patent or copyright royalty is utilized by the payer in the state. If and to the extent that the patent or copyright is used in a state in which the taxpayer is not taxable, the royalties are allocated to the taxpayer's commercial domicile. In Louisiana, which allocates all income from patents, trademarks, copyrights, secret

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processes, and similar intangible rights, the income is allocated to the state or states in which the rights are used. This rule is analogous to the allocation to a state of rentals and royalties from tangible personal property to the extent the property is used within the state. Apportionment FORMULA: DELINEATION OF THE FACTORS Once a TP determines s/t is apportionable income, he must apportion it among the states in which he carries on his business. (Already considered the const factors, which are loose, so now consider the individual factors.) Most states have adopted the three factor (property, payroll, and receipts) formula. The weight that each state accords to each factor (as well as their precise definition), however, differs. (Page 20/IV(B)(ii) introduced this.) Historically, the three factors were averaged, so that if a corporation had 40% of its property, 35 percent of its payroll and 15 percent of its sales in the state, its apportionment percentage would be 30 ([40+35+15] /3); and it would apportion 30 percent of its income or capital stock or other measure of the tax to the state. Today, roughly half the states put additional weight (usually double) on the sales factor, so that the corporation described in the preceding sentence would have an apportionment factor of approximately 26 percent ([40 + 35 +15 + 15]/4). i. Property factor. Only tangible property can be put into this category. Have to make this system simple so easy to apply. Whole three factor test is arbitrary anyhow. Rules they pick make it easier on accountants. Value is average value take beginning of year (Dec 31) and property owned this Dec 31 and then divide by 2. And we do not care about the fluctuations. UDITPA 10 & 12. Says multiply rent by 8 in order to find out how much property is worth. a. State Dep't of Revenue v. Amoco Prod. Co., 676 P2d 595 (Alaska 1984). b. Property under construction. Generally not included in formula. c. Property available for use is included even if idle, as long as available for use. ii. Payroll factor. Almost no litigation under this factor. Sections 13 and 14 of UDIPTA. It was decided long ago that people should be considered as working in only one state, so taxed where services performed, and if performing in multiple states, then where base of operations are, etc. If too hard to tell, then place of residence. This is helpful for accountants. Policy was we do not want people to get unemployment benefits from many diff states. a. Cincinatti, New Orleans and Texas Pacific Railway Company v. Kentucky Dept of Revenue. Told to work for this subsidiary, etc. and reimbursed by the subsidiary, so really working for subsidiary. Question is who puts these employees in their payroll factor? The court holds it is included in subsidiary they worked for as they were paid by the subsidiary and the parent had no control over the employee once leased. b. 7up case. Court held that since parent was paying the salaries, should be included in their payrolls, even though really working for subsidiary. iii. Receipts of Sales Factor. All the states imposing corporate taxes measured by net income use a receipts or sales factor. a. The terminology varies. UDITPA and some non-UDITPA state statutes use the term sales factor, and other states use the term receipts factor. Whatever term is used, however, the factor has a much broader scope than receipts from sales of property.

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It typically covers receipts from services, rentals, royalties, sales of stock, and business operations generally. ii. The inept term sales factor may have been adopted because the three-factor formula had its origin in, and was designed for, mercantile and manufacturing companies. Some states use the more appropriate term receipts to describe the factor. iii. The universe of receipts included in the receipts factor is generally defined by reference to the receipts that give rise to apportionable income. Consequently, if dividends are allocated to the state of the taxpayer's domicile, they are not included in the sales or receipts factor. Similarly, some states exclude receipts from sales of capital assets or from Section 1231 transactions from the scope of the sales factor. In states whose laws purport to apportion all income, no such limitation is ordinarily applicable. All the taxpayer's receipts taken into account in determining net income likewise are included in the receipts factor. utilized five different methods in determining the attribution of receipts from interstate sales to the numerator of the state's sales factor: i. destinationsales shipped into or delivered to customers in the state; a. Gilmour. A Penn corps sales of goods to out of state purchasers, who retrieve the goods at the sellers place of business and then transport the goods out, should not be included in the Penn corps calc of corp net income tax under the Code. b. MTC Regs say they should be, though. ii. originsales of goods shipped from a location in the state; a. throwback rule: Selling taxpayer is not taxable in state where item is delivered and property is not sold by agent based out of state, then thrown back from state of destination to state of origin. b. Throwout rule: receipts otherwise assigned to a state in which the TP is not taxable are eliminated from or thrown out from both the numerator and denominator of the sales factor. iii. sales officesales arising from negotiations at, from, or through an office or other place of business in the state; iv. sales activitysales resulting from employee activity in the state; v. place of acceptancesales responsive to orders accepted in the state. Rents and royalties from real and tangible personal property. UDITPA follows traditional rule of allocating rents and royalties if they constitute nonbusiness income, but apportion if they are business income.

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Chapter 8 - Sales Taxation Introduction Delineation of Taxable Sale Distinguishing tangible Personal property from services or intangibles The True Object and Similar Test Computer Software Sales of a Bundle of Distinct Property and Services in a single contract i. Some circumstances its possible to "unbundle" the sale of what appears to be a "mixed transaction into two separate transactions, which are treatable as taxable or nontaxable in their own right. Dell v. Superior Court Mixed sale in which a Dell computer and service K sold at the same time, for a single undifferentiated price on the invoice, is partially taxable as to the tangible prop and nontaxable as to the service k (b/c state doesnt tax intangible prop). Service K is a distinct and separately identifiable component of the transaction entitled to individual tax treatment. Where services and tangible property are inseparably bundled together, determination of the taxability of the trans turns upon whether the purchasers "true object" was to obtain the finished product or service. Tax rules allow allocation btwn taxable and nontaxable items bundled together if the value of the nontaxable item is separately stated. Bundled v. mixed transactions Mixed trans - the separate elements of the transaction are analyzed as separate trans for tax purposes. Unlike bundled transactions, the goods and services in a mixed trans are distinct (not intertwined) and each is a significant object of the transaction (not one incidental to the other). In mixed trans, the separate elements of the trans are analyzed as separate trans for tax purposes. Separate Statement Rule: General rule, is that the vendor must separately state the charges for the respective sales in order for the sales to receive separate treatment. (prop v service). Rule of tax administration, in circumstances where one can reasonable separate the components of a transactions, and in fact are separate, you must list them separately to receive separate tax treatment. Leases of Tangible personal property as a Sale A. Retail Sale In principal reaches sales only to ultimate consumer, however fails sometimes b/c treats bizz purchases as ultimate consumer even though those purchases will be reflected in subsequent selling of goods/services. Economically all of these should be treated the same way. Makes no difference, all of it shows up in the final price. Sale for Resale Exemption McDonalds v. commissioner

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Whether retail sales tax applies to a business's purchase of goods/service depends on whether it is resold in its regular course of bizz or incidental to the transferor's bizz, serving only to facilitate the consummation of the principal transactions. Often tied to whether bizz is engaged in rendering services or in selling tangible personal property. C. Manufacturing, Processing, and Fabrication exemptions Materials in question are not purchased for final consumption but rather for resale in the form of the final manufactured product. Materials purchased must become an integral or component part of the product that is ultimately to be sold at retail. Tax on final consumption Kaiser Steel v. SBE Primary purpose test is used for the purchase of raw materials to determine their taxability. Look to the primary intent of the purchaser or primary purpose of the purchase, was it for aiding the manufacture or was it to be directly incorporated into the product. If dual purposes at the outset, can proportion between taxable/nontaxable parts (some districts/other its all nontaxable) Policy to tax materials at their highest value rather than at a tiny fraction of that value. Machinery and Equipment Early sales taxes generally applied to these purchases, modern trend is to exempt such purchases when made for use in manufacturing tangible personal prop that is sold. Today a majority of states w/ sales taxes exempt these purchases. Policy: (1) to avoid pyramiding of the tax/double tax (2) encourage economic activity, esp in the location of industrial plants/in their state. Concord publishing v. Director of Revenue Equipment must be used directly in manufacturing of product. What comes out of the system is clearly different from what went into it. Computers in this instance to produce newspaper. Some courts interpret the phrase "directly used" to exempt only those machines that physically alter raw materials to a finished product ("physical change test"). Other adopt the "Integrated plant doctrine", viewing manufacturing operations as continuous and indivisible, should encompass all equipment that is an integral part of the prod process. One more test, "adaptation of materials to commercial use" Ok if btwn separate corporations, must be coordinated and necessary step in the manufacturing process, not as mere by-product disposal. Physical distance not determinative. Containers and Packaging

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CHAPTER 8: SALES TAXATION Introduction . Section 1: The Classification and Nature of Sales Taxes i. Sales Tax: any tax which includes within its scope all business sales of tangible personal property at either the retailing, wholesaling, or manufacturing stage with the exceptions noted in the taxing law.

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General retail sales tax is most significant sales tax in the state. It is a single stage levy on consumer expenditure (i.e. only applies to final sales for personal use and consumption) Sales taxes may be subdivided into three categories: a. Vendor Taxes: sales taxes whose legal incidence rests on the vendor (vendor has primary responsibility for reporting) b. Consumer taxes: Sales taxes imposed upon the retail sale of property or services, and they are measured by the same price of the goods or services. c. Hybrid taxes: contain features of both. Section 4: The Relationship Between the Fundamental Structural Flaws in the Retail Sales Tax and the Principal Legal Controversies it Raises Background a. Many of the most troublesome legal questions that arise again and again in the course of sales tax adjudication can be traced directly to two fundamental structural flaws i. The first flaw is that the retail sales tax does not tax only household consumption, but also includes substantial business purchases within the tax base ii. The second flaw is that the sales tax base is confined largely to sales of tangible personal property and does not generally extended to sales of services or intangible property The Taxation of Business Purchases a. From a normative standpoint the very notion of business consumption is an oxymoron. Since the sales tax base is designed to be a tax on personal consumption, business consumption by definition lies outside its scope b. Hence, there is simply no need to inquire into the question whether any business purchases are taxable since on the basis of first principle, they are exempt. c. The notion of business consumption becomes an inquiry into physical rather than economic consumption, an inquiry that has little to do with the underlying purposes of a retail sales tax and one that predictably leads to confusing and inconsistent results in the cases. The Limitation of the Sales Tax Base to Sales of Tangible Personal Property a. Merely including services or intangible property would get rid of most of the hardest cases. i. It would no longer be necessary to determine the true object or dominant purpose of a transaction when tangible and intangible were inseparable. ii. the only question would be if it was purchased for household consumption. Retail Sales Tax Section 1: Territorial Restraints State sales taxes are limited to retail sales occurring within the state Section 2: Delineation of Taxable Sale Generally

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States have generally confined their retail sales taxes to sales of tangible personal property. i. Although most states tax some services and some states tax many services, the inclusion of services in the sales tax base remains the exception rather than the rule. ii. Therefore, courts frequently confront the question whether a particular transaction constitutes at taxable sale of tangible personal property on the one hand or a non taxable sale of services on the other. Taxable Sales of Tangible Personal Property as Distinguished From Nontaxable Sales of Services or Intangibles: The Personal Service Transaction Exemption a. Background i. If a sale involves a transfer that is limited to tangible personal property or a transfer that is limited to services or intangibles its taxability is not in doubt. ii. However, many transactions do not fall squarely into one category or another because they are composed of transfer of tangible personal property AND services etc. iii. To deal with this problem many states have adopted a specific statutory exemption from the sales tax base for personal service transactions which involve sales as inconsequential elements for which no separate charges are made. iv. See Washington Times & Southern Bell b. Washington Times v. DC, pg 703 i. Facts ii. The newspaper publishing company contracted with several syndicates for its supply of comic strips. iii. The syndicates carry out these contracts by sending the newspaper mats bearing impressions of the current sequence of strips. a. The mats are manufactured by the syndicates from the original drawings by a photo engraving process. iv. The newspaper pays far more than the mats, without the strip on them, would be worth. (~150x more) v. The tax court upheld the sales of the mats at 30 dollars to be sales at retail and subject to taxation at that price. vi. State sales tax exempts from sales and use taxes personal service transactions which involve sales as inconsequential elements for which no separate charges are made. vii. A sale is an 'inconsequential element' where the price of the tangible personal property is less than ten per cent of the amount charged for the services rendered. viii. Held ix. The syndicates sold to the Times-Herald the right to reproduce one time the work of artists who make the drawings. They simply sold the professional and personal services of the artists whom they had under contract and in so doing transferred title to the mats, of inconsequential value, from which the drawings could be reproduced.

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The price was paid for the artists' work, i.e., for the right to reproduce the impressions on the mats, - not for the mats themselves. The newspaper bought the creation of the artist - not the material on which it was impressed - and the right to reproduce it. Without that right, the comic strips mats would be entirely worthless. Notes Relative Cost of Tangible Personal Property as the Determining Factor Whether a Transaction Involves a Taxable Sale a. Many courts disagree with the position taken above that there is a sale of a service rather than a sale of tangible personal property if the value or price of the materials that go into the product furnished to the consumer is inconsequential as compared to the charge for the services involved i. Voss v. Gray (ND): there is no article fabricated by a machine or fashioned by the human hand that is not the fruit of the exercise and application of individual ability and skill. And few indeed are the instances where the greater part of the cost thereof is not chargeable to personal service directly or remotely applied. ii. Craig-Tourial v. Reynolds (Ga): We do not think that the actual cost or monetary value of the materials used is determinative. However, we think that the main consideration should be the purpose of the customer who primarily wishes to buy the skilled services of the shoe repairman. Under such circs the sale of various grades or qualities of materials by the shoe repairman is really incidental to and but a means of rendering the services which his customers want. What about software? Two dollar CD, but 100 dollar program on the CD. a. Make peace with this by looking at the universe of transactions towards which the exemption is directed only professional, insurance, or personal services. Southern Bell v. Dept of Rev, pg 706 Facts Petitioner telephone company contracted with various artists for sketches and finished artwork to be used by its sales force, and in its telephone books. Under the contracts, the artists were paid for their services regardless of whether their work was used in marketing or actual advertisements. Respondent Department of Revenue sought to impose a sales tax, penalties, and interest on the artwork. Petitioner asserted that the artwork was exempt from sales tax as it was produced as an inconsequential part of the contract for the artists' services. When SB buys speculative and finished art, it is really purchasing the artists idea and the fact that the idea is transmitted on

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tangibpe personal property is an inconsequential element of the transaction vii. this decision based on several factors a. Whether or not the property to be transferred as a result of the transaction is ALREADY IN EXISTENCE or whether it is produced in the course of the services rendered b. The value of the individual effort involved in the transaction as compared to the value of the property transferred c. Whether or not it is essential to the transaction that the specific tangible personal property be created. viii. Using these factors, found artwork (not stock art) transferred to SB was created solely in the context of the particular transaction and not prior to them. The value of the services performed was much greater than the value of the tangible persona property. ix. Additionally it was not necessary for SB to actually take possession of the pX art it just would have been cost prohibitive not to. x. Held xi. the artwork was incidental to the services contracts and therefore statutorily exempt from sales tax. Taxable Sales of Tangible Personal Property as Distinguished From Nontaxable Sales of Services or Intangibles: The True Object and Similar Tests. (***REMEMBER IF SOMETHING CAN EASILY BE UNBUNDLED THAT IS LEGITIMATE COURSE OF ACTION) a. Navistar v. State Bd of Equalization, pg 710 Not in book i. Facts ii. A company sold all the assets of its subsidiary, including drawings and designs, manuals and procedures, and computer programs. iii. In an audit of the company, the State Board of Equalization determined that these three categories of assets were tangible personal property subject to sales tax, and the board assessed a deficiency against the company. iv. The company paid the deficiency, and after the company unsuccessfully sought a refund from the board, the company and the buyer brought an action against the board for a refund. v. TRUE OBJECT TEST vi. When the transferred or sold assets involve not only tangible personal property, which is taxable, but also the performance of a service, which is not taxable, their classification is determined by the "true object" test. vii. The basic distinction in determining whether a particular transaction involves a sale of tangible personal property or the transfer of tangible personal property incidental to the performance of a service is one of the true objects of the contract; that is, is the real object sought by the buyer the service per se or the property produced by the service. If the true object of the contract is the service per se, the transaction is not subject to tax even though some tangible property is transferred.

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viii. ix.

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b. i. ii.

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Held The sale of the documents containing trade secrets and other intellectual work product, i.e., the drawings and designs and the manuals and procedures, was not a nontaxable transfer of intangible property. The sale of the documents was not incidental to the performance of a service. Moreover, the regulation does not render a sale nontaxable whenever its principal purpose is to transfer the intellectual content of a physical object. If the purchaser desires the object for its own sake, it is taxable under the regulation. The purchaser of the documents in this case bought them for their own sake, and there was no separate and distinct transfer of an intangible property right. The court also held that the computer programs, which had been developed originally for the seller's use, were not "custom computer programs." That exemption specifically applies to a program prepared to the special order of the customer. The sale to another of a program developed for one's own use does not qualify for the exemption. Notes The True Object and Similar Tests for Distinguishing Sales of Tangible Personal Property from Sales of Services a. WTAR Radio v. Commonwealth (Va): If the true object sought by the taxpayer is the service per se, the exemption is available but if the true object of the buyer is to obtain the property produced by the service, the exemption is not available. b. Two Semantic variations of the True Object Test; i. Dominant Purpose Test: if the dominant purpose of the transaction is the transfer of services the transaction will constitute a nontaxable sale of service ii. Essence of the Transaction Test: if the essence of the transaction is a sale of property it will be taxable. If the essence is the sale of service it will be exempt. City of Boulder v. Leanin Tree, pg 719 Facts The transactions in question were for original artwork by independent artists that the taxpayer copied to use in making greeting cards, then returned to the artist. The city tax code imposed a tax on the purchase price paid or charged for tangible personal property sold or used in the city. A tax was to be calculated only on the purchase price of the tangible property involved in a transaction. The city manager, rather than imposing a tax on the full purchase price of inseparably mixed transactions, implemented a "true" or "real object" regulation. Colorado defines "tangible personal property," in pertinent part, as corporeal personal property that may be seen, weighed, measured, felt, or touched or is in any manner perceptible to the senses.

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If the true object sought by the buyer is the service per se, the transaction is not subject to tax even though some tangible personal property is transferred. vii. The transfer to a publisher of an original manuscript by the author thereof for the purpose of publication is not subject to taxation. The author is the consumer of the paper on which is recorded the text of the creation. However, the tax would apply to the sale of mere copies of an author's works or the sale of manuscripts written by other authors where the manuscript itself is of particular value as an item of tangible personal property and the purchaser's primary interest is in the physical property. viii. Tax would also apply to the sale of artistic expressions in the form of paintings and sculptures even though the work of art may express an original idea since the purchaser desires the tangible object itself ix. Held x. the transactions at issue involved purchases of otherthan-tangible personal property, even if they included the transfer of tangible personal property as well, and the two portions of the transactions were not meaningfully separable. xi. There was no way to separate the value of the tangible medium from the value of the right to reproduce the image appearing on it. xii. The transactions were more akin to a transaction for the right to publish. xiii. Any doubt had to be resolved in the taxpayer's favor. xiv. The challenged transactions did not constitute the sale or use of tangible personal property within the city's tax code. Taxable Sales of Tangible Personal Property as Distinguished from Nontaxable Sales of Services or Intangibles: Computer Software a. Canned as Compared to Custom Made Software i. The practice of taxing canned but not custom made software collides with the widely applied principle under the sales tax that there is no justification for exempting custom made articles from tax, as long as the same article when bought off the rack IS taxable. ii. The explanation for the treatment of custom made software as nontaxable may lie in the fact that custom made software whose design and installation can involve considerable interaction between the vendor and purchaser is more plausibly characterized as a nontaxable service than is canned software. Sales of Separately Identifiable Property and Services Bundled in a Single Contract a. Generally i. Not every transaction involving the sale of both tangible personal property and services or intangibles requires an all or nothing analysis

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In some circs it may be possible to unbundled the sale of what appears to be a mixed transaction into two separate transactions, which are treatable as taxable or nontaxable in their own right. Dell v. superior court Tax rules sometimes allow allocation btwn taxable and nontaxable items bundled together if the value of the nontaxable item is separately stated. Bundled (goods or services, or goods + services) v. mixed transactions (goods and services) General rule is that the vendor must seperately state the charges for the respective sales in order for the sales to receive separate treatment. Rylander v. San Antonio SMSA Ltd Partnership, pg 732 not in Facts Appellant comptroller contended the services were taxable as "part of the sale" of telecommunications equipment because the services and equipment were sold under one contract of sale. Appellees argued that the line-engineering services were "readily separable" from the sale of the equipment and that only the equipment sale was subject to the imposition of sales tax. There was one contract of sale, but a charge for lineengineering services was listed separately from the cost of the equipment. There was a need for the engineering assessment that was as important to appellees as the equipment itself. Rule: When a mixed transaction is "readily separable" into two elements of equal value, the elements must be analyzed as separate transactions for tax purposes the property aspect of the transaction would be taxable and the service aspect of the transaction would not be taxable. when the components are each a consequential element capable of a separate and distinct transaction, then the elements must be analyzed as separate transactions for tax purposes. The existence of a single invoice or a single contract will not affect taxability. When "readily separable" transactions have been provided, each transaction must be analyzed independently to determine if a sales tax shall be imposed. Held Transactions for line-engineering services and sale of equipment were "readily separable" because the engineering assessment was as important as the equipment and neither was incident to the other; Therefore, the two distinct transactions had to be analyzed separately for sales tax purposes and engineering services were not taxable. Notes The Separate Statement Rule a. Where the sale of tangible personal property can arguably be separated from the sale of services, the general rule

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is that the vendor must separately state the charges for the respective sales in order for the sales to receive separate treatment i. Ky Admin Reg: If the labor and other services are not thus shown separately from the selling price of the property furnished, it will be presumed that the entire charge represents the sale price of the property and the tax applies thereto. b. In Rylander the court noted one invoice, but separate line charges. Retail Sale, pg 744 Generally A retail sales tax in principle only reaches only sales to the ultimate consumer. i. Every state retail sales tax contains a sale for resale exclusion. ii. Most sales taxes also exclude sales of components or ingredients of property produced for sale iii. Similarly, many states exempt the purchase of machinery and equipment used in manufacturing property for sale as well as property consumed I the manufacturing of articles for sale. Despite the theoretical premise that the retail sales tax is a single state levy on consumer expenditures and the existence of provisions designed to complement that premise sales tax falls short of that goal. Purpose is to ensure that only the final sale to the consumer gets taxed and that there is no pyramiding of the tax by imposing it on intermediate purchases as well. Sale for Resale Exemption McDonalds v. comissioner Regular course of bizz (not taxed) v. consumed (taxed) Fairlawn Shopper Inc v. Director Division of Taxation, pg 745 NOT in book i. Facts ii. Plaintiff Fairlawn Shopper, Inc., owns, publishes, and distributes a newspaper entitled the "Fairlawn Shopper." iii. The newspapers are primarily distributed free-of-charge and their revenues are derived almost entirely from advertising. iv. The newspapers are actually produced by independent contract printing firms, which supply the necessary paper, ink, and dyes, printing the paper with their own machinery and employees. a. Plaintiffs nonetheless supply most of the substantive content of the newspapers. v. The finished product is delivered by the printers to plaintiffs, who distribute the newspapers to the public on a weekly basis. vi. The amount of the tax in issue represents sales or use tax on the portions of the printers' bills to plaintiffs that represent the cost of printing services as well as materials other than newsprint. vii. A retail sale is defined as a sale of tangible personal property to any person for any purpose, other than for resale either as

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x. xi.

xii.

xiii. xiv.

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such or as converted into or as a component part of a product produced for sale by the purchaser. Statute imposes a tax on the receipts from every sale, except for resale, of the following services: Producing, fabricating, processing, printing or imprinting tangible personal property, performed for a person who directly or indirectly furnishes the tangible personal property, not purchased by him for resale, upon which such services are performed. A sale for resale is established under New Jersey law when the consideration for the resale comes from a third party other than the consumer. Held The court found that the definition of "sale" in the New Jersey Sales and Use Tax Act meant that the consideration required to satisfy the definition of a sale had to be based upon third parties. The court agreed with the trial court that appellant's purchases were exempt. In effect, the advertisers are subsidizing the readers of these papers to the extent of the price per copy that the publisher would otherwise charge the consumer. Notes Scope of Resale Provision a. Mendoza Fur Dyeing Works v. Taylor, pg 750 i. Facts: The taxpayer was in the business of dyeing and processing fur skins owned by dealers and manufacturers. The taxpayer contended that the taxpayers purchases of dyes were excluded from the definition of a retail sale sa a sale for resale on the ground the dyes maintained their chemical character after completion of the dye4ing process and that the dyer is therefore NOT the ultimate consumer of the dye. ii. Held: The mere fact that some part of the product so sold to the dyer adheres to the property of another upon which his services are performed and such part is discernible by microscopic examination is insufficient to make the dyer a vendor of the dyes and chemicals purchased by hid. iii. Upshot: Technically, some tangible personal property is transferred, BUT dyer is not reselling the dye, but RATHER the service of dyeing with the incidental transfer of personal property. The TRUE OBJECT is the service of dyeing. Sales for Resale and the Rendition of Services a. Courts have held that sales of linens, soap, paper towels napkins, cups, and stationary to hotels for use by their guests are retail sales for consumption by the purchaser in rendering services to their customers.

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xi. a. i.

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When a hotel purchased food and bev which it offered to guests as part of a package deal, a La court concluded that the purchases were exempts as a sale for resale i. In those cases dealing with the initial purchase by a business of goods normally furnished to a customer as an incident of providing a professional service, the initial sale has been held to be a retail sale and not a sale for resale. Where goods are not furnished as a normal incident to the furnishing professional services and the price of the goods is separable and can be established the initial sale is not a retail sale but a sale for resale. c. Professionals are generally treated as rendering services. Accordingly lawyers are taxable on the paper they purchase for preparing contracts, wills etc. i. Likewise dentists must pay tax on crowns because they are used in providing a service, not to be resold. Institutional Purchases on Meals and the Resale Exclusion a. Airlines and other institutions that purchase the meals they serve often contend that they purchase the meals for resale. There is a split among divisions. Manufacturing, Processing, and Fabrication Exemptions Generally The sales tax provision of every state exclude or exempt purchases of materials for use in the manufacturing, processing, or fabricating of tangible personal property for sale. The theory underlying these exclusions or exemptions is the same theory that underlies the sale for resale provision the materials in question are not purchased for final consumption but rather for resale in the form of the final manufactured product. For this reason these provisions often require that the materials purchased become an integral or component part of the product that is ultimately to be sold at retail. Kaiser Steel Corporation v. State Bd of Equalization, pg 758 Facts A steel manufacturer sought a refund of sales and use taxes paid with respect to materials purchased for use in the manufacturing process that were incorporated into slag which was later sold by plaintiff to another company, alleging that such materials had been purchased for the purpose of resale. The trial court concluded that plaintiff's "primary purpose" for purchasing the raw materials determined their taxability, and found that the State Board of Equalization's conclusion that plaintiff purchased the materials primarily to aid in manufacturing steel was reasonable. Accordingly, the trial court ruled that the purchases of raw materials were subject to sales and use tax.

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If property is purchased as an aid in the manufacturing process, it is taxable despite the fact that some portion remains in the finished product or that an incidental waste or by-product results. Conversely, if the property is purchased for incorporation as a component of the finished product, it is not taxable despite the fact that some portion may be lost or otherwise dissipated in the manufacturing process. a. If the sole purpose of purchasing the aluminum is to incorporate it into the finished product ultimately sold, the sale of the aluminum will be treated as a sale for resale and no tax will be due even with respect to that portion lost or wasted in the manufacturing process. Where there are simultaneous uses but only one or primary purpose for the purchase, the entire unit of material is taxed or not taxed, depending on that purpose. When the entire unit is first utilized as an aid in processing or manufacturing and subsequently incorporated into a manufactured product to be sold, the entire unit is taxable. Held The primary intent of the purchaser or primary purpose of the purchase was the test to determine whether a sale is taxable as a retail sale or exempt as a sale for a resale, and that such test was applicable to the manufacturing industries. The court held it was evident from the record that plaintiff's dominant motive or purpose in purchasing the materials in question was to use them in removing the impurities from its molten steel, a "purpose other than resale" and that although plaintiff intended eventually to resell the materials in the form of slag, it first used all of the materials in question in a nonexempt manner, thereby determining their taxability. The eventual resale of personal property by a person who purchased such property for use will not prevent the original sale of such property from being a retail sale subject to tax. Notes Ingredients or Component Part of Manufactured Product: Other Steel Production Cases a. Nucor Steel v. Herrington (Neb): if a substantial part of the material becomes an ingredient of the finished product, even though there are pother primary uses for the material and the rest is consumed in the manufacturing process, ALL of the material constitutes an exempt ingredient. b. Van Dyk v. Dept of Rev (Wash): the purchase of coke used in manufacturing iron was exempt from tax on the ground that the important fact for application of the ingredient exemption is that a necessary ingredient is supplied, not that the quantity is small i. Granite City Steel v. Dept of Rev (Ill): Disagreed with Van Dyk. Employed a split the baby

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approach, and only exempted that which became infused as carbon into the iron Primary purpose test Kaiser, this is largest tax base at intermediate consumption Substantiality test: Nucor Steel substantial ingredient if sub part of material b/m ingredient of finished product even though other primary uses for material and rest is consumed in the process ALL material exempt ingredient Necessary ingredient: Van Dyke best result for txpr, broadest being exempt Generous a necessary ingredient is supplied not the quantity is small Split the baby, apportionment: Granite city Steel Divided the purchased prop b/w the exempt and taxable portion 2. Machinery or Equipment Used in the Manufacture, Production, or Processing of Tangible Personal Property to be Sold . Generally . Although the early sales taxes generally applied to the purchases of industrial machinery and equipment, the modern trend is to exempt such purchases when made for use in manufacturing tangible personal property that is to be sold (i.e. a wheel aligning machine purchased by GM nothing becomes infused into final product, BUT used to produce what resold and the COST of USE is in the product. i. Exemption of machinery is warranted because the category constitutes a major element in the cost of manufacturing with no logic for taxing it. ii. If used directly in the process OK. If use is only indirectly, legislature draws the line iii. i.e. tables and chairs by IBM are too indirect. Machine that assembles computers IS alright, even if nothing infused into computers. a. Concord Publishing v. Director of Rev, pg 769 . Facts i. Appellant Director of Revenue assessed sales and use tax on certain computer equipment purchased and used by respondents, publishing company and corporation, to implement changes in the production process and format of a newspaper and to increase the number of newspapers sold. ii. Statute exempt the following: Machinery and equipment, and the materials and supplies solely required for the installation or construction of such machinery and equipment, replacing and used for the same purposes as the machinery and equipment replaced by reason of design or product changes, which is purchased for and used directly for manufacturing or fabricating a product which is intended to be sold ultimately for final use or consumption.

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Neither sales nor use tax is due on machinery and equipment used directly in manufacturing a product, which is intended to be sold ultimately for final use or consumption vii. if the machinery or equipment was purchased a. to replace existing equipment by reason of design or product changes b. or to expand existing manufacturing. viii. Although some courts strictly interpret the phrase "directly used" to exempt only those machines that physically alter raw materials to a finished product, Missouri has adopted the "integrated plant doctrine", viewing manufacturing operations as continuous and indivisible. ix. To limit the exemption to those items of machinery or equipment which produce a change in the composition of the raw materials involved in the manufacturing process would ignore the essential contribution of the devices required for such operation. x. A regulation promulgated under exempts machinery purchased to increase production volume, even if the increase is potential but has not been actualized. xi. Held xii. Machinery that increases production volume qualifies for exemption. xiii. Notes xiv. Scope of Manufacturing a. Manufacturing has become subject to numerous tests i. Physical Change Test: defines manufacturing as the process of changing the form or composition of materials. ii. Adaptation of Materials to Commercial Use: i.e. recycling used metal drums iii. Integrated Plant Test (See Concord): Manufacturing should encompass ALL equipment that is an integral part of the production process. 3. Containers and Packaging . Exemption of Containers and Packaging Under Resale Provisions . The issue in these cases usually turns on the courts view as to whether the taxpayer is using the container or packaging in the course of delivering its product or is separately selling the container or packaging i. DC v. Seven Up Washington (DC): cardboard cartons, wooden cases, and bottles purchased by soft drink bottlers for use in delivering hteir products were purchased for use, not for resale. a. The purpose was to use them, not to resell them. Respondents are not in the business of selling bottles or cases but of using them as a means as a means of marketing their soft drinks. a. Reusable Bottles, Cases, and Other Containers . When bottles and other containers are reusable, courts generally hold they are taxable. i. Some courts however have held that reusable soft drink bottles are purchased for resale by bottlers. They usually stress the fact that title to

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the bottle passes to the purchaser who is free to do with the bottles whatever she pleases. b. Statutory Exemption of Containers and Packaging Materials. . Because of the difficult issues raised by containers and packaging under the resale provisions, most states have addressed the issue by statute. The statues typically provide that the sale of the container to the vendor is a nontaxable sale for resale. 4. Section 4: Taxation of Services 5. Introductory Note . Whatever the historical explanation for the limitation of the sales tax base to sales of tangible personal property it certainly does not lie in the dictates of sound fiscal or economic policy. Reasons to favor taxing services: . Service inclusion alleviates regressivity and improves neutrality i. Inclusion makes the sales tax more income elastic ii. Service inclusion can raise much revenue iii. Inclusion is administratively feasible. a. Despite historical reluctance to extend the sales tax to services, economic and fiscal pressures are pushing them strongly in that direction. . There has been a gradual expansion fo the sales tax base to selected services i. utilities ii. hotel/ motel iii. repair of tangible personal property iv. repair of real property v. data processing vi. cleaning services vii. However, states have not extended the sales tax base to the services that would generate the greatest revenues viii. construction ix. professional services x. health care 6. Repair, Alteration, and Servicing of Tangible Personal Property . Covington Pike Toyota v. Cardwell, pg 787 . Facts i. In addition to engaging in the business of selling new and used automobiles, Covington sells extended warranty service contracts to cover the cars purchased from them. ii. These contracts, entitle the purchasers to certain repair services free of charge at participating Toyota dealerships all over the United States after expiration of the original manufacturer's warranty. iii. After being audited the taxpayer was assessed a deficiency in sales and use taxes, penalty, and interest for the warranties. iv. Although the car sales to non-residents were not taxable, and therefore no sales taxes were assessed on the cars, the Commissioner taxed Covington's sales of extended warranty service contracts to cover those cars on the basis of a statute granting taxing authority for repair for a consideration of any repair services with respect top any kind of tangible personal property.

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Taxation statutes must be liberally construed in favor of the taxpayer and strictly construed against the taxing authority. vi. Conversely, exemptions are construed against the taxpayer, who bears the burden of proving entitlement to the exemption. vii. Held viii. The commissioner overstepped his rule-making authority because the word "repairs" did not include the undertaking of a contractual commitment whereby repair services could, or could not have been, provided in the future. 7. Telecommunication Services, pg 793 . Ruling 95-10 (Conn) . How It Works i. The general rule for imposing tax on telecom services in Conn are when a call a. both originates and terminates in Conn b. originates in Conn and terminates outside Conn and is charged to a telephone number in Conn c. originates outside Conn and terminates within Conn and is charged to a telephone number in Conn. ii. The tax based on the full sales price of the telecom service that would have been paid without the use of a prepaid phone card MUST BE REMITTED by the telecom provider at the time the call is made, and should be charged to the user by debiting the amount of the tax from the prepaid units remaining on the users card iii. You are buying the right to acquire telecom services iv. Sale of cards is not taxable, the telecom services rendered when used ARE taxable. v. This one is technically the most sound policy wise, but the hardest to maintain and implement. a. Private Letter Ruling No 95-0431 (Ill) . The tax base would be the amount charged to the card purchaser for the taxable service subsequently provided. i. When the cards are sold in Illinois, the department presumes that the calls will originate or terminate in this state. ii. The client would have the burden of proving particular cards were sold to be used outside of Illinois. b. Sales Tax Newsletter (ND) . Sales of prepaid telephone calling cards are sales of tangible personal property. i. Prepaid telephone cards sold within the state of ND are subject to sales tax, regardless of where the long distance calls purchased with the cards originate or terminate. 8. Section 5: Real Estate Construction and Repair . GS Lyon v. Department of Rev, pg 802 . Facts i. The company is engaged in the business of selling building materials in Decatur, Illinois.

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During the period involved here, it sold materials to real-estate developers or speculative builders who incorporated them into structures on land they owned themselves. iii. Such builders construct houses or other improvements on land they own, and later sell the improved properties to prospective home owners and other buyers. iv. In some of the instances the builders, prior to beginning construction or purchasing any materials, had made an oral agreement to sell the home to be built. v. The dept of rev assessed taxes measured by its sales of building materials to real estate developer or speculative builders. vi. The legislature intended the term "use," in the Retailers' Occupation Tax Act, includes any employment of a thing which takes it off the retail market so that it is no longer the object of a tax on the privilege of selling it at retail. vii. Once off the market, the materials themselves are not resold for a direct and specific consideration. viii. The personal property has been transformed by the process of building and in every sense contemplated by the act it is used or consumed in the process of construction or fabrication. ix. The controlling factor in determining taxability is the purpose for which the material is bought and in ascertaining this purpose the mere matter of who owns the land is of little significance. x. Held xi. It was taxable to the contractor xii. Notes xiii. Generally a. Construction contractors are generally treated as the consumer of the building materials it purchases and uses in constructing or adding improvements to real estate. The Taxation of Interstate Sales . Section 2: Apportionment of the Sales Tax Measure a. Oklahoma Tax Commissioner v. Jefferson Lines, pg 856 . Facts a. An Oklahoma statute imposed a 4 percent tax on the gross receipts or gross proceeds of each sale of transportation for hire. b. Pursuant to another Oklahoma statute, the buyers of such transportation services paid the taxes, and the sellers collected the taxes and remitted them to the state. c. After a Minnesota corporation that had provided bus services as a common carrier in Oklahoma filed for bankruptcy protection in the United States Bankruptcy Court for the District of Minnesota, the Oklahoma tax commission filed proof of claims for uncollected taxes with respect to tickets for interstate travel sold by the corporation in Oklahoma. d. The corporation objected to the claims on the ground that the tax violated the Federal Constitution's commerce clause

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Where the taxing state is where a bus ticket is purchased, and the service originates there, these facts give the taxing state a sufficient nexus to tax the transaction under the first prong of the Complete Auto test. External consistency looks not to the logical consequences of cloning, but to the economic justification for a state's claim upon the value taxed, to discover whether a state's tax reaches beyond that portion of value that is fairly attributable to economic activity within the taxing state. a. A state's tax on ticket sales for travel originating in that state is externally consistent, as reaching only the activity taking place within the taxing state, that is, the sale of the service. Internal consistency is preserved when the imposition of a tax identical to the one in question by every other state would add no burden to interstate commerce that intrastate commerce would not also bear. a. As with a tax on the sale of tangible goods, the potential for interstate movement after a sale has no bearing on the reason for a sales tax. Only Oklahoma can tax a sale of transportation to begin in that state, and when it imposes the same duty on equally valued purchases regardless of whether the purchase prompts interstate or only intrastate movement, there is no discrimination against interstate commerce. Held a. Oklahoma's sales tax on the full price of a ticket for bus travel from Oklahoma to another state was consistent with the commerce clause, because b. the sale of interstate transportation services had a sufficient nexus to Oklahoma as the state where the ticket was purchased and the service originated; c. the tax was properly apportioned; d. the tax did not discriminate against interstate commerce; and e. the tax was fairly related to the services provided by the state. SCALIA (concur) a. expressed the view that b. the tax did not facially discriminate against interstate commerce and thus did not violate the commerce clause; and c. the other criteria used by the Supreme Court to determine the validity of the tax under the commerce clause should not have been applied. BREYER (Dissent) a. expressed the view that the Oklahoma tax violated the commerce clause, because the tax was an unapportioned tax upon interstate commerce and a fairly obvious effort to tax more than that portion of revenue from interstate travel which reasonably reflected the in-state component of such travel. Notes a. The Congressional Overruling of Jefferson Lines b. Congress provided as follows i. A state or political subdivision thereof may not collect or levy a tax, fee, head charge, or other charge on

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a.

A passenger traveling in interstate commerce by motor carrier b. The transportation of a passenger traveling in interstate commerce by motor carrier c. The sale of passenger transportation in interstate commerce by motor carrier d. Or the gross receipts derived from such transportation.