United States: Report Released On Proposed Amendments To Multistate Tax Compact’s Division Of Income Provisions

Professor Richard Pomp has released a detailed document, termed the Report of the Hearing Officer, which analyzes proposals and makes recommendations for amending key provisions of Article IV of the Multistate Tax Compact.1 Article IV concerns the division of income and incorporates the provisions of the Uniform Division of Income for Tax Purposes Act (UDITPA). Professor Pomp issued the report after conducting a public hearing and considering numerous comments. The report explains that it "provides a background to the amendments, a summary of the proposals' substantive features, a review of the public testimony, and the Hearing Officer's comments and recommendations, including in some cases, his proposals for a redrafted statute."


In 1957, the Uniform Law Commission (ULC) promulgated UDITPA to provide uniform laws that states could adopt to assign the taxable income of multistate corporations among the states in which they do business. The Multistate Tax Commission (MTC) created the Compact in 1967 and included the UDITPA provisions as Article IV. Due to the significant changes in the U.S. economy since the creation of UDITPA, some of the important uniform provisions were thought by some to be outdated and many states have enacted legislation that departs from these provisions. As a result, the MTC recommended in 2006 that the ULC start a project to revise UDITPA.2 After public hearings and comments, the ULC decided to discontinue its work on revising UDITPA in 2009. The MTC soon started to consider its own revisions to Article IV and its Uniformity Committee completed its work in March 2012. The MTC's Executive Committee approved the proposed model for public hearing in December 2012.

Apportionment Factor Weighting

The Compact currently provides for a three-factor apportionment formula consisting of equally-weighted property, payroll and sales factors.3 However, many states have moved away from this standard formula and require that multistate taxpayers apportion income using a single sales factor or a three-factor formula with a double-weighted sales factor. The Uniformity Committee recommended that the Compact be amended to recommend a double-weighted sales factor to Compact states, but ultimately allow these states to define their own factor weighting fraction.

In endorsing the Executive Committee's approach, the Hearing Officer explained that the "proposal to allow states to define the factor weighting fraction is a concession to reality" and that "[t]he recommendation of double weighting is unlikely to have much effect." The Hearing Officer addressed the potential criticism that this approach hinders uniformity by considering the increase in specific industries that have specialized apportionment formulas. Also, the Hearing Office explained that "perhaps uniformity should be viewed on an industry basis, rather than on a more general level." The Hearing Officer concluded that "the march to a single sales factor can still be expected to continue" and the "most useful role for the MTC is to continue its cooperative efforts with the private sector to formulate industry-specific rules of apportionment."

Equitable Apportionment

Under the Compact, if the general allocation and apportionment provisions do not fairly represent the extent of the taxpayer's business activity in the state, the taxpayer may petition for or the tax administrator may require an alternative apportionment methodology.4 The Uniformity Committee recommended adding a new paragraph providing that if the allocation and apportionment provisions do not fairly represent the extent of business activity of taxpayers engaged in a particular industry, transaction or activity, the tax administrator may establish rules or regulations, to be applied uniformly, for determining alternative allocation and apportionment methods.

The Hearing Officer proposed a new version of the equitable apportionment provision. The existing language would be amended to replace the specifically enumerated alternatives with "any reasonable method to effectuate an equitable allocation and apportionment of the taxpayer's income." The Hearing Officer also proposed two new paragraphs to clarify equitable apportionment issues. Under these proposals, the tax administrator would be authorized to publish rules and regulations when the general allocation and apportionment provisions do not fairly represent the business activity of taxpayers that are engaged in a particular industry, transaction or activity. Further, the party petitioning for, or the tax administrator requiring, an alternative apportionment method, has the burden of proof. If the tax administrator requires the use of an alternative apportionment method, civil or criminal penalties cannot be imposed if the taxpayer reasonably relied on the general apportionment provisions. Finally, a taxpayer permitted to use an alternative apportionment method may not have such permission revoked for transactions that have already occurred unless there has been a material change in, or a material misrepresentation of, the facts provided by the taxpayer.

Business Income

The Compact currently defines "business income" as "income arising from transactions and activity in the regular course of the taxpayer's trade or business and includes income from tangible and intangible property if the acquisition, management and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations."5 The Uniformity Committee recommended changing the term "business income" to "apportionable income" and revising the definition to "all income that is apportionable under the Constitution of the United States and is not allocated under the laws of this state, including: (A) income arising from transactions and activity in the regular course of the taxpayer's trade or business, and (B) income arising from tangible and intangible property if the acquisition, management, employment, development, or disposition of the property is or was related to the operation of the taxpayer's trade of business."6

The Hearing Officer proposed a revised draft that would define "apportionable income" as "all income that is apportionable under the Constitution of the United States and is not allocated under the laws of this state, including but not limited to: (A) income related to the operation of the taxpayer's trade or business; or (B) income from tangible [and] intangible property if the acquisition, management, employment, development, or disposition of the property is, or was, related to, or part of, the operation of the taxpayer's trade or business." The revised draft clarifies that the transactional test in (A) and the functional test in (B) are independent of each other. Unusual situations not included within either category would be tested under the constitutional standard.7

Market-Based Sourcing

Under the Compact, sales, other than sales of tangible personal property, are sourced to a state (on an all-or-nothing basis) if: (i) the income-producing activity is performed in the state; or (ii) the income-producing activity is performed both in and outside the state and a greater proportion of the income-producing activity is performed in the state than in any other state, based on costs of performance (COP).8 The Uniformity Committee proposed a total revision of this provision that would replace the COP standard with a market-based sourcing approach intended to mirror the destination principle used to source sales of tangible personal property. Specifically, sales of other than tangible personal property are sourced to a state if, and to the extent, the taxpayer's market for the sales is in the state. To determine whether a taxpayer's market for sales is in a state, the proposed draft includes a series of sub-rules that describes the sourcing for different types of transactions including transactions involving intangible property.9 If the taxpayer is not taxable in a state to which a sale is assigned or if the state of assignment cannot be determined or reasonably approximated, the sale is excluded from the denominator of the sales factor (this is commonly termed a "throwout rule"). According to the Hearing Officer, "[t]hese proposed changes, the most sweeping of all the amendments, generated most of the discussion at the [h]earing."

The Hearing Officer recommended revising the COP method by replacing the "all-or-nothing" method under the current COP standard with a proportionate approach, rather than adopting the market-based sourcing approach proposed by the MTC. Also, the MTC regulations should be revised to better define the direct costs that are included in COP.10 The Hearing Officer also explained that there would be value in extending COP to independent contractors. The controversy concerning how to define an "income-producing activity" could be addressed by viewing the entire apportionable business income of a unitary business as the income-producing activity. Because the nexus requirement would be satisfied by this origin-based COP approach, the Hearing Officer noted that there would be no need for a throwout or throwback rule. However, the Hearing Officer acknowledged that "COP is incompatible with the economic development considerations that led to single-factor apportionment." Therefore, states that have adopted single sales factor apportionment would be unlikely to adopt COP.

Receipts Factor

The Compact currently defines "sales" as all of a taxpayer's gross receipts that are not allocated.11 The Uniformity Committee recommended that the term "sales" be replaced with "receipts." The recommended language would define "receipts" as the gross receipts of the taxpayer that are not allocated and that are received from transactions and activities in the regular course of the taxpayer's trade or business.12

The Hearing Officer proposed two alternative drafts for the definition of "receipts."13 The drafts eliminate the "gross receipts of the taxpayer that are not allocated . . ." language because receipts are not allocated.14 Under the first alternative, "receipts" is defined as "gross receipts of the taxpayer that are received from, or associated with, transactions or activities generating apportionable business income defined in Art. IV.1." The Hearing Officer explained that the first alternative is broader than the Uniformity Committee's proposal and the second alternative. The first alternative implements the principle that for apportionable income, the related receipts should be included in the sales factor so that the apportionment formula is more likely to be fair and reflect a reasonable sense of how income is generated. The second alternative contains the same language as the first alternative, but adds language to exclude "substantial amounts of such gross receipts from an incidental or occasional sale of a fixed asset or other property that was, or is, related to, or part of, the operation of the taxpayer's trade or business." Also, the second alternative excludes some situations that might otherwise raise issues of alternative apportionment.


The proposals to revise Article IV of the Compact have received considerable attention. There have been discussions to revise key provisions of UDITPA or Article IV for many years. Although all five of the main topics discussed in the report are important, the changes proposed to the alternative apportionment and market-based sourcing provisions may be the most wide-ranging and controversial. With respect to the scope of alternative apportionment, the question of which party has the burden of proof when an alternative apportionment method is sought has been addressed in at least one high-profile case in the past year,15 with more litigation on this point likely to follow. The Hearing Officer's proposed amendment would clarify that the party invoking the alternative apportionment method has the burden of proof. State tax authorities are likely to argue that the burden of proof should always be on the taxpayer regardless of which party raises the issue, given the general presumption of correctness concerning assessments issued by the state. On the other hand, there are strong equitable arguments that can be raised by taxpayers that assert that the burden of proof should be same for either the taxpayer or the tax administrator, and that a taxpayer following statutory rules should not be subject to penalty if a state tax authority decides to assess based upon alternative apportionment.

During the past several years, market-based sourcing of sales other than sales of tangible personal property has become a popular departure from the UDITPA COP method. Under market-based sourcing, states generally require that receipts from the sale of services are sourced based on the location of the service provider's customers, or on the location where the customers received the benefit from the service provided, rather than the location where the service provider performed the services. The nuances of marketbased sourcing vary among states.16 Considering that states are moving toward marketbased sourcing, it is curious that the Hearing Officer recommended using a modified COP method rather than market-based sourcing. However, the Hearing Officer presumes that the Executive Committee will endorse the market-based sourcing approach and draft model regulations. The Hearing Officer explained that "[s]peed is of the essence if the MTC is to exert influence in this area" and that "[i]t can only be hoped that the states that have already marched down the path of market-based sourcing will reverse their current practices if those turn out to be inconsistent with MTC model regulations."

It will be interesting to see how the MTC responds to the Hearing Officer's report at its next executive meeting in December. The MTC could take steps to follow the Hearing Officer's guidance, retain its own drafted language, or strike a compromise between the two approaches. Also, it would stand to reason that even after final language to amend the Compact is adopted by the MTC, model regulations further explaining the new provisions in the Compact would need to be drafted. This would put the MTC in the interesting position of developing regulations to essentially self-interpret the issues that it raised in the revised Compact. Of course, the biggest issue that will be unresolved for some time is whether the states will be motivated to change their statutes (and regulations) to conform to the provisions in a revised Compact. If not, the MTC's project will be remembered for spurring a significant amount of intellectual discourse, but not a lot of practical success.


1 Report of the Hearing Officer, Multistate Tax Compact Article IV (UDITPA) Proposed Amendments, Oct. 25, 2013. The report is available at http://www.mtc.gov.

2 The MTC recommended that the following provisions be reviewed: (i) sales factor numerator sourcing for services and intangibles (market-based sourcing) (Compact Art. IV.17); (ii) sales definition (Compact Art. IV.1(g)); (iii) factor weighting (Compact Art. IV.9); (iv) business income definition (Compact Art. IV.1(a); and (v) equitable apportionment (Compact Art. IV.18).

3 Multistate Tax Compact Art. IV.9.

4 Specifically, the MTC provides for: (i) separate accounting; (ii) the exclusion of one or more of the factors; (iii) the inclusion of one or more additional factors which will fairly represent the taxpayer's business activity in the state; or (iv) the employment of any other method to effectuate an equitable allocation and apportionment of the taxpayer's income. Multistate Tax Compact Art. IV.18.

5 Multistate Tax Compact Art. IV.1(a). Note that the first part of the definition, "income arising from transactions and activity in the regular course of the taxpayer's trade or business," is commonly called the "transactional test." The second part of the definition, "income for tangible and intangible property if the acquisition, management and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations," is commonly called the "functional test." Furthermore, "nonbusiness income" is "all income other than business income." Multistate Tax Compact Art. IV.1(e).

6 Also, the definition includes "any income that would be allocable to this state under the Constitution of the United States, but that is apportioned rather than allocated pursuant to the laws of this state."

7 As explained by the Hearing Officer, the proposed language in (A) and (B) is broad enough to accommodate new business practices, but the constitutional standard will be available for the gray areas.

8 Multistate Tax Compact Art. IV.17.

9 These sub-rules include provisions for sourcing such items as real property, tangible personal property, services and intangible property. However, because the Uniformity Committee anticipates development of model regulations, the draft language leaves many questions unanswered.

10 Certain categories of costs, such as depreciation, research and development, sales and marketing, technical support and billing, cause most of the problems in computing COP.

11 Multistate Tax Compact Art. IV.1(g).

12 The definition would exclude the receipts of a taxpayer other than a securities dealer from hedging transactions and from the maturity, redemption, sale, exchange, loan or other disposition of cash or securities.

13 Both drafts assume that Draft Art. IV.17(a)(4)(ii)(C) has been adopted and receipts from the treasury function and hedging do not need to be addressed in the "receipts" definition. This section of the marketbased sourcing draft provides that all other receipts from a sale of intangible property are excluded from the numerator and denominator of the sales factor.

14 Gain or loss, rather than receipts, is allocated.

15 In Equifax, Inc. v. Department of Revenue, Mississippi Supreme Court, No. 2010-CT-01857-SCT, June 20, 2013, the taxpayer used the standard method of apportionment for service companies, but the Department of Revenue used an alternative apportionment method consisting of market-based sourcing. The Mississippi Supreme Court held that the taxpayer had the burden of proof because the party petitioning the court for relief bears the burden of proving its claim by a preponderance of the evidence or a higher standard. In this case, the Department presented minimal evidence to support its claim that the standard apportionment factor initially used by the taxpayer failed to reflect the extent of its business in the state. For further discussion of this case, see GT SALT Alert: Mississippi Supreme Court Upholds Use of Alternative Apportionment Method.

16 Some of the more recent state legislation adopting market-based sourcing requires sales to be sourced to the location where the service is delivered. For example, legislation recently enacted by Massachusetts (Ch. 46 (H.B. 3535), Laws 2013) and Pennsylvania (Act 52 (H.B. 465), Laws 2013) follows this approach.

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