State Allocation and Apportionment - Assignment Example

allocation and apportionment The theory behind the allocation and apportionment depicts that corporation’s total net income is channelized and it is a simple concept of multi-state income taxation. Allocation refers to an assignment of ‘non-business income’ of a particular state. In fact this non business income is considered as an income which arises out of activity that is not related to the corporation’s own business. For example , income acquired by a business corporation by means of a parcel of out –of state- real estate which is not related to the business of the manufacturing house and generally be treated as non business income. This kind of non-business income will be allocated in full amount to the state. This kind of particular income is assigned to the state and it depends on the factors like the location of the property, whether the property is intangible or not and on the commercial domicile of the taxpayers. (Roth, 1999, 67) The term apportionment refers to an assignment of the income of taxpayer on the basis of a formula. Such business income is generated by the activity which occurs in an organization in regular intervals. The formula is based on the ratio of the activity of the taxpayer in the state to total activity. There is a limited uniformity in the practice of the apportionment and it is always subject to risk of “overlapping taxes” on the commerce within the state itself. In fact there is no legislation for ensuring uniformity. However the state has taken many steps to achieve a high degree of uniformity through the act called as “UDIPTA”. A multi-state tax compact requires that the states joining the compact to enact with the act. Most of the states participate in the multi-state compact but their extent of participation varies. This variation results in a significant diversity in the formulas of apportion. (CCH, 2005) Apportionment Formula The apportionment formula is defined as percentage of apportion multiplied by the total income generated out of business activity. The formula of apportionment is based on the three factors which have equal weights. However unequal weights of these three factors are sometime also used. The three factors of the apportionment formula are property factor, sales factor and payroll factor. Now these three factors can be given equal weights or sometime magnitude of weights may not be equal. Now consider first the property factor of the apportionment formula. The factor property measures to which extent the taxpayer uses the property in order to generate business income in the state. The numerator of the respective factor is the mean value of the personal and real property of the taxpayer within the taxing state. This personal property can also be rented within the taxing state. On the other hand the denominator of the property factor is the mean value of all the properties which are owned or rented by the taxpayer within the taxing state during a particular financial period. The regulations of Multi-state Tax Compact limit this factor to its use. It excludes the use of property in the production process of non-business income. Here the property is tangible and real which includes machinery, buildings, equipments, stock of goods etc. but it does not include paper currency or coins. Again property factor can also include partnership property, work and construction which are in progress. (Roth, 1999) Another factor of the apportion formula is the sales factor. It measures the sales activity of the tax payer within the taxing state. Here other kind of sales is also taken into consideration other than sales of tangible assets. The intangible sales of property are assigned to the state if and only if there is an income generating activity within the taxing state. The income is accumulated from the receipts in the form of loyalty, dividends or interest. This business income is assigned to the taxing state as because the income generating activity is occurred within the state itself. But if tax payer’s income does not come under tax net in the country where selling is made, the sale is assigned to that country where property is delivered. Each state imposes corporate tax on the profit of the corporate house doing business within the country and in this context it is very important to determine that tax rate. Now to determine such kind of tax rate it is important to know the percentage share of the organization’s sales within the country. But when corporate sales are not assigned to any state i.e. if the particular portion of the total profit is untaxed then this phenomenon is known as “nowhere income”. Now to ensure that all corporate profits are under tax net, throwback rule can be used. In USA throwback rule is used to ensure that each and every part of corporate profits comes under tax net. Now we consider the third factor of the apportionment formula – the payroll factor. The payroll factor is defined by Uniform Division of Income for Tax Purposes Act. This act considers the payroll factor as the total amount to be paid by the tax payer in the country during the tax assessment year. (CCH, 2005) ‘Compensation’ in the form of salaries, commissions, wages and other such kind of remuneration paid to the workers is defined by the regulations of both Uniform Division of Income for Tax Purposes Act and Multi-state Tax Compact. (Weiner, 2005) The payroll factor includes all the amounts such as housing, the value of board, rental charges, lodging expenditure and other different categories of benefits and services of the employees that form the income that comes under IRC. (CCH, 2005, 594) This factor of apportionment formula includes all the compensations that go to an employee who provides services in the state entirely. Uniform Division of Income for Tax Purposes Act provides payroll as a factor of the apportionment formula which is based on the compensation paid to an employee. However, it can be seen that for some certain industries the apportionment formula does not give us the true and correct procedure to determine such factors. These kinds of industries may be rail, television service, radio broadcasting etc. In this regard there are some ‘Compensation’ in the form of salaries, commissions, wages and other such kind of remuneration paid to the workers is defined by the regulations of both Uniform Division of Income for Tax Purposes Act and Multi-state Tax Compact. (Weiner, 2005) The throw-back and throw-out laws determine the possibility of paying tax on income. That income may come under tax net in one country but other country may choose not to tax at the same time. This kind of problem may be addressed by the above mentioned two laws. The two laws have different mechanisms in operation. But the demerits of such two laws are similar in nature. Frankly speaking that these two laws, while calculating the amount of tax, requires a company to include income in another state if and only if the other state does not tax this income or there may be some laws stipulated by the U.S constitution that are not permitting to tax the income. (Weiner, 2005) Sometimes a corporate house does certain things to avoid such throwback. In situations where throwback provision is demanded and when the law of the destination state is not permitting to tax the organization, the tax payer may find a very odd situation to prove that it taxable in the destination state. Now we can consider why these two rules are necessary to adopt. Without such rules there is definitely a clear chance or opportunity for the multi-national companies to avoid taxation. Such multi-national organizations can reduce their tax burden by locating their payroll and property in the other states that do not have a throwback rule to adopt and then they are selling their products to the customers of such states with which the organization does not have a connection. The incident of minimization of tax burden puts other business houses in a disadvantaged position. The strategies that a corporation may take for minimizing the tax liability create distortion in the incentives it faces. This possibility drains out a huge amount of tax revenue and such amount of tax revenue could be used for financing long term public investments. These two rules help the state in reducing the fiscal deficit of the state by ensuring all profits earned by the business houses subject to taxation. (Weiner, 2005) Apportionment of business house’s taxable income in the state will be a fighting one. Everybody will try to grab his or her share without caring the rules. There is a difference of situation in the state tax apportionment scenario. In case of income tax of corporate houses there is an established law that the states will have discretion in adopting apportionment formula. Each state will have different formula of apportionment and a state can even impose hundred percent taxes on a corporate house as the case may be and this has been accepted by the court. (CCH, 2005) Corporate tax payers have also option in this score. The constitution has no real law limiting the apportionment of corporate income. The interpretation of the law is very difficult in this context and it may prevent the taxing authority for easy apportionment. The state is also prevented from collecting tax revenue on account of apportionment due to the restrictions imposed by state law. So the tax payers in the corporate sector face a dilemma in apportionment. Throwback rules and throw-out rules of apportionment may have a challenging phenomenon which corporate tax payers must identify as to which one will be helpful for them. (Weiner, 2005) A multiple accounting system is not in practice now a day especially with the government bodies which selects apportionment formula. In a corporate business house there are many sources of income generation for which separate accounting is not at all feasible. Maintaining so many records for accounting is not at all practicable. The geographical accounting has been challenged for apportionment as the source of income. In this context the court has given clear verdict that the income generated in a state by business houses is different and it can not be identified the total income of a corporate house for calculating the apportionment formula as the income is different from state to state. On the other hand division in respect of allocation of income depends on locations. Allocation of tax revenue of the state attributes to the geographical source of a certain item of net income. In South Carolina certain items of income are excluded from apportioned income. In the allocation method the following factors will be considered as income in business of corporate houses. In the first place, the business activity in manufacturing, the retail delivery to the buyer is made and the delivery to the buyer on whole sale basis and the royalties arising out of rights. The report under apportionment method will be submitted by the service industry and other business houses. The income in the business is apportioned by multiplication of service income by payroll factor of apportionment formula in addition to income from service factor which is divided by two: the total service income multiplied by the sum of payroll factor and service income factor divided by 2. The payroll factor is the total amount of tax which is paid for a certain period by the tax payer. The payroll is defined as the total compensation in a city divided by the same in everywhere. (ALLOCATION & APPORTIONMENT SCHEDULE INSTRUCTIONS, 1999) A number of states in the U.S.A. including South Carolina are assuring the tax payers that they tax multinational organizations in a very appropriate manner i.e. taxing on a multi-state basis. The policy does not allow taxing on a multi-state basis and for the out of state business. Thus the state overtaxes the corporate house on the basis of multi-state taxation. A tax payer having his business partly in South Carolina and partly outside South Carolina is subject to pay income tax for the portion of the business doing in South Carolina. In Vermont the percentage of apportionment is that if a taxable business organization conducting trade and business in the state the apportioned income will be full. If a taxable business organization does trade or any other kind of business activity partly in the state and partly out side the state the apportioned net income will be calculated in an arithmetic system in the following manner. On the basis of the real value of the property both inside and out side of the Vermont, the total salaries, personal services and the wages paid in a taxable year to employees both inside and out side Vermont and the total sales and service charge within Vermont and outside Vermont. The items of income from non business activity will be covered under the Vermont regulation. Tax payer’s property both real and tangible and his receipts and total sales will be computed with the percentage addition for asserting apportionment percentage. The payroll inside Vermont during a taxable period will have to be divided by three. If any factor is missing the other factors will have to be added and will be divided by 2. If only one factor is available then the apportionment percentage will be the remaining percentage. Supposing a tax payer has no personal property like house, real state from where he is receiving income with in the state or out side the state, in that case the apportionment percentage will be calculated through other two parameters i.e. Apportionment percentage will be computed by sales, payrolls and receipts with the division by 2. (Weiner, 2005) As a matter fact throwback rule permits to add the receipts in the numerator when there is no addition otherwise it is not included. A number of states accept this while others do not accept. This rule is applied by a state from where delivery of property which is personal in nature in order to grab the revenue for apportionment to the destination shipment. The justification of the state where it is originated is that if the receiving state of that shipment does not impose tax, the tax for that receipt can not be received by any other state. In throwback rule in Uniform Division of Income for Tax Purposes Act model it is required that tax payer is not liable to pay taxes in the states of purchased. A tax payer has to pay taxes for two reasons. These are his activity in business in another state and for the business in another state to impose corporate tax whether or not tax is imposed. This is the model but there are many throwback provisions across the states which are different in this model. The reasons for these kinds of different provisions of throwback rule are that the tax payer is not supposed to pay tax in the reaching state. In the state of Indiana in the U.S. the argument of the department of revenue is that one state must tax on the income of the corporate house whether it is inside the state or out side the state. If the shipment state does not impose tax then the destination state must get the tax. There is another situation where the customer of a corporate is government or sale by the tax payer to a foreign country. (Weiner, 2005) There are many differences in throwback rules and it has to be studied very carefully. The rules of the state are different and there is widespread argument against throwback rules whether the other state can tax a tax payer and the tax payer pays the tax in other state. In this case what is the law which will protect the tax payer from paying taxes in the state of destination? Two states have adopted throw rules in stead of throwback rules for apportionment formula of the state when there are no receipts. Throw-out rule is the rule which throws items from the denominator of the formula of the apportionment of the state. The receipts from “net worth taxes”, receipts taxes and Michigan business taxes are not thrown out in the throw-out rule. New Jersey throw-out rule is not only the receipts from sales of property but it includes the receipts gathered from other sources. New Jersey as a sate of U.S is getting throw-out receipts if it is not the origination or the destination state which is quite different from the rules of West Virginia. (Cline, n.d.) Many states in the U.S have tried to impose throw-out rules through administrative mechanism, for example Pennsylvania a U.S state was not having a throw-out rule but in 1984 this rule was applied on some tax payers by the commissioner through his administrative power. This rule was utilized for apportionment of income could not be done due to the clear picture of the activities of business of a tax payer. The court accepted the powers of commissioner of Pennsylvania for adjustment of apportionment of income. But after 6 years in another case the Pennsylvania Supreme Court turned its approval from the earlier position and the judgment was given regarding that the commissioner can not use his administrative powers for apportionment. In general the rules of apportionment of income are a complicated one. Tax deductions should be apportioned after allocation of gross income is made. There are complex rules for allocation and apportionment of income of the state. The apportionment formula has three factors namely the payroll factor, total receipts factor and the property factor. These factors are in place in most of the states for the apportionment of the income. But there are some variations also regarding the rules amongst the state for determination of receipts, property or employees of a tax payer and which one will be considered within the state. The Supreme Court has laid down the formula of apportionment approach which is a formula based on above mentioned three factors. This formula consisting of the three factors is the benchmark for judging the apportionment formula. (Roth, 1999) In the matter of apportionment of income although the government has discretion to apply and select the formula but it is not the entire discretion of the government. The government has certain limitations as per the constitution and the principles of the law of the state. In order to proper understating of apportionment approach one must not forget the constitutional barriers prevailing in the state and the imposition of legal limitations on the state. References 1. ALLOCATION & APPORTIONMENT SCHEDULE INSTRUCTIONS, (1999) available at: http://www.state.vt.us/tax/pdf.word.excel/forms/1999/ba-402i.pdf (accessed on January 28, 2009) 2. Cline R. (n.d.) “Changing Business Tax Systems: Something New?”, Quantitative Economics and Statistics Practice 3. Roth, W.V. (1999) International Tax Issues Relating to Globalization: Congressional Hearing, DIANE 4. C C H, Inc. (2005) U.S. Master Multistate Corporate Tax Guide, CCH Tax and Accounting. 5. Weiner, J.M. (2005) Formula Apportionment and Group Taxation, Taxation Papers, available at: http://72.14.235.132/search?q=cache:-_IbcoEhBX4J:bookshop.europa.eu/eubookshop/download.action%3FfileName%3DKPAA04008ENC_002.pdf%26eubphfUid%3D424259%26catalogNbr%3DKP-AA-04-008-EN-C+%E2%80%98Compensation%E2%80%99+in+the+form+of+salaries,+commissions,+wages+and+other+such+kind+of+remuneration+paid+to+the+workers+is+defined+by+the+regulations+of+both+Uniform+Division+of+Income+for+Tax+Purposes+Act+and+Multi-state+Tax+Compact&hl=en&ct=clnk&cd=3&gl=in (accessed on January 28, 2009) Read More