United States: Oregon Supreme Court Requires Use Of Transaction-Based Approach To Calculate Cost Of Performance For Sales Factor Purposes

On September 11, 2015, the Oregon Supreme Court held that under the cost of performance (COP) method for sourcing sales other than sales of tangible personal property, sales should be sourced using a transactional rather than an operational approach.1 In affirming the Oregon Tax Court, the Supreme Court held that the definition of "income-producing activity" as it applies to a COP analysis relates to individual sales to customers. As a result, only direct costs associated with the individual transactions should be considered.


AT&T, a global telecommunications company, operated its administrative headquarters and Global Network Operations Center in New Jersey during the relevant tax years. From this location, AT&T provided long-distance and international exchange services that connected users in Oregon with users in other states or countries. AT&T did not extend its physical network to the actual homes of its customers. Instead, AT&T provided service from and to points of presence, with "last-mile service" provided by local exchange carriers (LECs) to AT&T's ultimate customers, including customers in Oregon. During the years at issue, AT&T maintained a major piece of switching equipment used in the process of completing all types of calls. Upon the passage of a call to or from a customer's location, AT&T paid an access charge to the appropriate LEC for the "last-mile service."

For the relevant tax years, AT&T filed corporate excise (income) tax returns that sourced sales to Oregon. AT&T filed refund claims for the 1996 through 1999 tax years that used a network-based or operational approach in applying the "income-producing activity" used to source sales of interstate and international telephone and data transmissions. According to AT&T, its income-producing activity was the operation of a global telecommunications network. AT&T supported its refund claims with a detailed cost study that compared its costs incurred in Oregon to those incurred in New Jersey. This study showed that the costs incurred in New Jersey exceeded the costs incurred in Oregon in every instance. Because the greatest portion of the COP was located in New Jersey, not Oregon, AT&T argued that none of its relevant sales revenue should be sourced to Oregon.

The Oregon Department of Revenue rejected the refund claims and argued for a transaction-based application of "income-producing activity." Under this approach, the Department considered the activity that produced each individual interstate and international telephone and data transmission billed to an Oregon customer. Because the majority of these specific costs related to each individual transaction in question was incurred in Oregon, the Department argued that the sales should be sourced to Oregon. The Department contended that AT&T's tax liability would remain unchanged from its initial tax returns. AT&T appealed the Department's rejection of its refund claims to the Oregon Tax Court.

The Oregon Tax Court agreed with the Department and denied AT&T's request for a refund.2 According to the Tax Court, Oregon's apportionment statutes and administrative rules required a three-step analysis: (i) determine the items that are included in "incomeproducing activity;" (ii) determine the gross receipts from that transaction; and (iii) determine where the direct COP occurred geographically. Regarding the first step, the Tax Court held that the statute and administrative rules required a focus on individual transactions with customers, but AT&T had focused on entire groups or classes of transactions. As a result, AT&T's cost study did not identify the correct income-producing activity and thus distorted its COP calculation. AT&T subsequently filed an appeal with the Oregon Supreme Court.

Oregon Requires Use of Transactional Approach

The Oregon Supreme Court affirmed the Tax Court's decision and agreed that AT&T must use a transactional, rather than operational, approach to source the sales. Because AT&T's cost study used an operational or network approach, it did not correctly calculate the COP for the correct income-producing activities. Therefore, the Court held that AT&T failed to meet its burden of proof that it was entitled to a refund.

Sales Factor Sourcing Statute

Oregon follows the traditional apportionment methodology of the Uniform Division of Income for Tax Purposes Act (UDITPA) that was adopted as Article IV of the Multistate Tax Compact.3 Sales of tangible personal property are sourced to Oregon if the property is delivered or shipped to a purchaser in the state.4 The Court explained that this statute focuses on individual sales to purchasers and generally reflects the state's contribution as a market toward the taxpayer's income. Also, a sale of tangible personal property is sourced to Oregon if the property is shipped from Oregon and: (i) the purchaser is the U.S. government; or (ii) the taxpayer is not taxable in the state of the purchaser (this is known as a throwback rule).5 The Court focused on the throwback rule and noted that UDITPA emphasized the interest of making all of the taxpayer's income taxable somewhere over reflecting the market state's contribution to the transaction.

Sales other than sales of tangible personal property are sourced to Oregon if: (i) the income-producing activity is performed in the state; or (ii) the income-producing activity is performed both in and outside Oregon and a greater proportion of the income-producing activity is performed in Oregon than in any other state, based on COP.6 The Court explained that the application of this statute depends largely on the precise meanings of "income-producing activity" and "costs of performance." The Department argued that the activity is transaction focused and applies to each individual telephone call or separate monthly billing. In contrast, AT&T contended that the term refers to broad portions of its business. If this system-based or network-based interpretation were accepted, large portions of revenue would be sourced to a single state.

The Court made two observations about the text of the Oregon statute for apportioning sales other than sales of tangible personal property. First, AT&T correctly noted that the provision does not look to the market where the sales occur. Rather than considering the location of the taxpayer's customers, the statute looks to where the taxpayer effectively produces the income. Second, the statute seems to connect the term "income-producing activity" with particular "sales." This interpretation would parallel the statutory treatment of sales of tangible personal property that attributes each individual sale to a particular state. According to the Court, this implies that the income-producing activity in the statute means the activity that produces the income associated with a particular sale. However, the Court acknowledged the statute is ambiguous and this is not the only possible way to read this provision. Because there was room for doubt at the statutory level, the Court considered the Department's relevant administrative rules as a means to interpret the ambiguity.

Sales Factor Sourcing Administrative Rules

The Department adopted an administrative rule to interpret the sourcing statute that is based on a model regulation promulgated by the Multistate Tax Commission (MTC).7 The rule clarifies the statute by providing that "gross receipts are attributed to this state if, with respect to a particular item of income, the income producing activity is performed within and without this state but the greater proportion of the income producing activity is performed in this state, based on costs of performance."8 The Court noted that the rule adds that an "income-producing activity" is something that generates "gross receipts" and results in an "item of income." The rule also provides that "income-producing activity" applies "to each separate item of income and means the transactions and activity directly engaged in by the taxpayer in the regular course of its trade or business for the ultimate purpose of obtaining gains or profit."9 The Department successfully argued that "item of income" means an individual exchange between a buyer and a seller. The Court held that this interpretation was plausible and not inconsistent with the statute, rule, or with any other source of law.

After identifying the income-producing activity, a determination must be made where the taxpayer performs the activity. If the income-producing activity is performed in more than state, the taxpayer must determine whether "the greater proportion of the income producing activity is performed in this state, based on costs of performance."10 This requires the taxpayer to compare the COP in different states. The administrative rule defines "cost of performance" as "direct costs determined in a manner consistent with generally accepted accounting principles and in accordance with accepted conditions or practices in the trade or business of the taxpayer."11

Taxpayer Failed to Prove Greater Part of Costs Was Incurred in Other States

In affirming the Tax Court, the Supreme Court agreed with the Department and held that a transactional approach should be used in sourcing the sales. The Court explained that AT&T was required to: (i) show the COP for each income-producing activity; and then (ii) show that the greater part of those costs had been incurred in some state other than Oregon. According to the Court, AT&T's cost study did not identify the correct incomeproducing activities. As a result, AT&T failed to provide evidence showing that, in connection with its sales of interstate and international voice and data transmission, a greater share of the COP for each income-producing activity was incurred in a state other than Oregon. The Court agreed with the Department's interpretation that was focused on individual transactions with customers. As discussed above, the administrative rule indicates that "income-producing activity" is something associated with an individual "item of income." The Court determined that the Department's interpretation of "item of income" to relate to individual sales, either per-minute charges for phone calls or flat-rate monthly subscriptions, was plausible and not inconsistent with any sources of law identified by AT&T.

The Court held that AT&T's network-focused interpretation of income-producing activity was too broad and distorted its calculation of the COP. The direct costs of the incomeproducing activity, each individual phone call or monthly flat-rate billing, are only those incremental costs associated with each individual call or billing. AT&T's cost study included network costs, but a transaction-based interpretation of income-producing activity means that network costs do not qualify as direct costs. The Court determined that AT&T's cost study did not identify the correct income-producing activities and did not correctly calculate the COP for those activities. Therefore, AT&T did not meet its burden of proof that it was entitled to the refunds.


In this case, the Oregon Supreme Court provides guidance in interpreting a UDITPA sourcing provision that is unclear and has caused confusion for taxpayers, particularly service providers engaged in large, multistate businesses. The provision for sourcing sales other than sales of tangible personal property does not specify whether a transactional or operational approach should be used when determining "income-producing activity." After deciding that a transactional approach should be used, the Court acknowledged that this is not the only possible way to read this provision. The Court focused on the "item of income" language in the Oregon administrative rule that is based on an MTC regulation in requiring AT&T to use the transactional approach.

It has been widely discussed that Oregon and Massachusetts have reached different results on this issue. In another case involving AT&T, the Massachusetts Appeals Court affirmed a decision of the Massachusetts Appellate Tax Board and held that an operational approach should be used.12 However, the Massachusetts Department of Revenue subsequently issued guidance concerning the implications of this case.13 The Department explained that the case represents a determination "in the context of one specific fact pattern."14 According to the Department, "[i]n general, the appropriateness of the transactional approach will depend on the nature of a taxpayer's activity the performance of which creates an obligation of a particular customer to pay a specific consideration."15 Thus, the Department clarified that a taxpayer's facts and circumstances should be considered in deciding which approach to use.

The conflicting approaches make it practically impossible for multistate companies to use a consistent approach in states that use COP sourcing, and this problem may have critical implications in determining the overall level of taxability in these states. Requiring companies to track and geographically determine the costs associated with each individual transaction based on the transactional approach (the approach taken by Oregon) would likely be a highly difficult task considering the volume of transactions and the multitude of locations from which calls are placed and received. For this reason, the operational approach has been used as a proxy by many companies in the absence of more detailed information. Under the operational approach, determining the overall cost associated with the operation and management of the long-distance telecommunications hub in New Jersey in comparison to costs incurred in other states is likely to be done with more ease than determining costs associated with each individual transaction under the transactional approach. Of course, the use of different approaches in this area can result in a significantly higher or lower aggregate apportionment percentage for multistate taxpayers, depending upon specific facts and circumstances.

1 AT&T Corp. v. Department of Revenue, Oregon Supreme Court, No. SC S060150, Sept. 11, 2015.

2 AT&T Corp. v. Department of Revenue, Oregon Tax Court, No. TC 4814, June 28, 2011. For a discussion of this case, see GT SALT Alert: Oregon Tax Court Requires Use of Transactional Approach to Determine Sales Factor Calculation.

3 Oregon codifies UDITPA at OR. REV. STAT. §§ 314.605-314.675. In July 2014, the Multistate Tax Commission amended UDITPA and adopted a market-based sourcing approach.

4 OR. REV. STAT. § 314.665(2).

5 Id.

6 OR. REV. STAT. § 314.665(4).

7 OR. ADMIN. R. 150-314.665(4).

8 OR. ADMIN. R. 150-314.665(4)(1).

9 OR. ADMIN. R. 150-314.665(4)(2).

10 OR. REV. STAT. § 314.665(4).

11 OR. ADMIN. R. 150-314.665(4)(4).

 12 Commissioner of Revenue v. AT&T Corp., 970 N.E.2d 814 (Mass. App. Ct. 2012). Note that Massachusetts changed to market-based sourcing for tax years beginning on or after January 1, 2014. Ch. 46 (H.B. 3535), Laws 2013.

13 Technical Information Release 13-12, Massachusetts Department of Revenue, Aug. 20, 2013.

14 Id.

15 Id.

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