Wednesday, August 11, 2010

Recent South Carolina Apportionment Decisions

Two recent decisions confirm the broad alternative apportionment authority granted by S.C. Code § 12-6-2320, and recognize that alternate apportionment methods can be used by the South Carolina Department of Revenue (SCDOR) and the taxpayer to determine corporate income tax liabilities.

S.C. Code Ann. § 12-6-2320 gives the SCDOR or the taxpayer the ability to use “any method” that equitably allocates and apportions a taxpayer’s income in the event that the standard allocation methods within the South Carolina Income Tax Act “do not fairly represent the extent of the taxpayer’s business activity” in South Carolina.

Media General Communications, Inc., et al. v. South Carolina Department of Revenue, Opinion No. 26828 (S.C. Sup. Ct. June 14, 2010) (“Media General”).

Multistate corporations (taxpayers) sought contested case review before the South Carolina Administrative Law Court ("SCALC") of a determination by the SCDOR employing the standard income apportionment method to calculate the corporations' state tax liabilities. The parties stipulated before the SCALC that South Carolina uses the separate entity apportionment method to determine the taxable income related to intangible property of multistate businesses doing business in South Carolina, and further stipulated that the combined entity apportionment method results in a fair computation of the taxpayers' business activities in South Carolina. The SCALC concluded that the plain language of S.C. Code Ann. § 12-6-2320(A)(4) permits use of the combined entity apportionment method favored by the taxpayers.

The South Carolina Supreme Court affirmed, rejecting the SCDOR’s arguments 1) that the definition of “taxpayer” found in the Revenue Procedures Act required tax returns to be filed by a single entity, 2) S.C. Code Ann. § 12-6-2320(A)(4) does not expressly allow use of the combined entity apportionment method; and 3) the SCDOR had never employed this method before.

CarMax Auto Superstores West Coast, Inc. v. South Carolina Department of Revenue, Docket No. 09-ALJ-17-0160-CC (SCALC April 22, 2010) (“CarMax”).

In CarMax, the SCALC determined that S.C. Code § 12-6-2320 allowed the SCDOR to use of a "bifurcation" apportionment method as an alternative to the standard apportionment method.

A SCDOR audit resulted in a determination that the use of the standard statutory formula did not fairly represent the extent of the taxpayer’s business in South Carolina. Consequently, the SCDOR used an alternative apportionment method by which it isolated the taxpayer’s income derived from retail activity from its South Carolina a) income derived from intangibles that it licensed and b) financing receipts. More specifically, this “bifurcation” method apportioned the income from financing and royalties, by means of a ratio of the financing and intangible receipts in South Carolina to the financing and intangible receipts from all locations in which the taxpayer conducted business.

The taxpayer claimed that the alternative apportionment statute did not apply because the income was from a “unitary business”, and thus no portion can be considered separately for apportionment reasons.

In rejecting the taxpayer’s argument, the SCALC reasoned that “[t]he significance of considering the taxpayer's South Carolina source income apart from its retail operations is inherent in the language of § 12-6-2320 regarding 'the extent of the taxpayer's business activity in this State." Moreover, a “separate accounting” is a method expressly permitted by § 12-6-2320(A)(1)."

Taxpayer Implications

These cases demonstrate that the South Carolina Income Tax Act, specifically S.C. Code Ann. § 12-6-2320 thereof, gives both the SCDOR and the taxpayer the flexibility to propose alternative apportionment methods, keyed to an accurate determination of the business the taxpayer is doing in South Carolina.