Alternative Apportionment: Tough for the Taxpayer, (Too) Easy for the States

By Glenn C. McCoy Jr., J.D., and Pietro M. Stuardi, CPA, Holtz Rubenstein Reminick LLP, New York City

Editor: Alan Wong, CPA

State & Local Taxes

In recent years, the proliferation of different methodologies in state apportionment has intensified the concerns over double taxation and the overall fairness of apportionment rules. Alternative apportionment provisions aim to provide limited relief through the possibility of “opting out” of the standard apportionment formulas when their application would produce particularly inequitable results. As a matter of fact, however, these provisions mostly have been used by the states as an additional tool to claim a bigger slice of the pie.

In a perfect world, multistate businesses would be able to apportion their income in a manner that properly reflects their economic activity in each state. In the real world, it has been recognized that it is impossible to provide a precise answer to the division of income question (Container Corp. of America v. Franchise Tax Bd., 463 U.S. 159 (1983)). Apportionment formulas instead are used to approximate the amount of income that a business earns within a state. As is the case with approximations, situations exist where the income allocated to a state under the standard methodology is clearly inconsistent with the extent of the activities in that state. Such a distortion is more likely to affect nontraditional industries such as service providers, information technology companies, or businesses that integrate traditional operations and financial services.

The U.S. Supreme Court has thus far been reluctant to disturb the statutory apportionment formulas mandated by the states (but see Hans Rees’ Sons v. North Carolina ex rel. Maxwell, 283 U.S. 123 (1931), in which a single-factor formula was found to be arbitrary and unreasonable). However, many state statutes incorporate a specific provision that is intended as a last resort in those limited circumstances when the standard approach would be grossly inadequate. Most statutory schemes provide that the state tax authority may require, and the taxpayer may petition for, a departure from the apportionment formula if the apportionment provisions do not fairly represent the extent of the taxpayer’s business activity in the state. In fact, the Multistate Tax Commission (MTC) model statute includes a similar provision. Under the MTC formulation, when circumstances require, income may be allocated through the use of separate accounting, the exclusion of one or more of the factors from the formula, the inclusion of additional factors, or any other method that may result in an equitable allocation of the income (see Uniform Division of Income for Tax Purposes Act (UDITPA), §18).

Taxpayers May Request Alternative Apportionment

When the taxpayer seeks an alternative apportionment method, it must generally make a formal request to the state taxing authority. Although states vary in their requirements, the relevant statutes generally require that the request be made in advance of filing a tax return or at least filed with the return taking the position. Such a request should include all information for the proposed alternative as well as the tax calculated thereunder. In addition, taxpayers sometimes request a ruling approving alternative apportionment in advance.

Typically, there is a presumption in favor of the standard formulary apportionment, premised on the theory that it favors uniformity between the states. To overcome the presumption, the taxpayer generally is required to prove distortion, or gross distortion, and show that an alternative method is adequate (see Container Corp. of America v. Franchise Tax Bd., 463 U.S. 159 (1983); UDITPA, §18). To support an argument that applying the state’s statutory apportionment methodology would create the required distortion or an unconstitutional tax as applied to them, taxpayers often use separate accounting to show where income is earned geographically and support a claim of distortion (see In re British Land (Md.), Inc. v. Tax Appeals Tribunal, 85 N.Y.2d 139 (1995)). Alternatively, taxpayers have unsuccessfully sought to depart from the standard formulas showing that the payroll factor did not account for geographical differences in the cost of labor, or that the low profitability of a specific jurisdiction is not reflected by the statutory apportionment method (see John Deere Plow Co. v. Franchise Tax Bd., 238 P.2d 569 (Cal. 1951); Fleming v. Oklahoma Tax Comm’n, 157 F.2d 888 (10th Cir. 1946); and Crane Co. v. Carson, 234 S.W.2d 644 (Tenn. 1950)). Indeed, regardless of the approach adopted by the taxpayer, case law shows that meeting the burden of proof to justify the departure from a standard formula may be a daunting task.

States Can Also Seek Alternative Apportionment

Conversely, state tax authorities have been more successful than taxpayers in exercising their discretionary authority under the alternative apportionment provisions. Often the states argue that the standard formulas need to be adjusted when applied to a company’s treasury department, which is traditionally separate from the main line of business and has a substantially different level of profitability (see Microsoft Corp. v. Franchise Tax Bd., 39 Cal. 4th 750 (2006)). Other cases initiated by state taxing authorities were designed to force members of affiliated groups to report and apportion their income on a combined basis, overriding the statutory separate-filing method (see Wal-Mart Stores East, Inc. v. Hinton, 676 S.E.2d 634 (N.C. Ct. App. 2009), appeal dismissed, 689 S.E.2d 375 (N.C. 2009); and Delhaize Am., Inc. v. Lay, No. 06-CVS-08416 (N.C. Super. Ct., Wake Co. 1/12/11) (currently on appeal).

Further, state tax authorities have attempted to impose their discretionary authority to depart from the statutory cost-of-performance sourcing method of sourcing sales of intangible property and services. In such cases, the state generally applies sourcing rules based on the location where the customers receive the benefits of the services, resulting in a more beneficial apportionment for the state (see BellSouth Adver. & Publ’g Corp. v. Chumley, 308 S.W.3d 350 (Tenn. Ct. App. 2009), appeal denied, No. M2008-01929-SC-R11-CV (Tenn. 3/1/10); and Ameritech Publ’g, Inc. v. Wisconsin Dep’t of Rev., 788 N.W.2d 383 (Wis. App. Ct. 2010)).

State Courts Defer to State Tax Departments

There is a trend in the case law that seems to grant too much discretionary authority to state tax departments. Presumptions in favor of the taxing authorities and judicial deference to the departments’ positions are key factors tending to create an imbalance; likewise, the burden of proof that must be met to override the standard apportionment rules appears substantially lower when it is initiated by the state, as opposed to the taxpayer. A recent example of this trend is found in Indiana Dep’t of State Rev. v. Rent-A-Center East, Inc., 952 N.E.2d 387 (Ind. Tax Ct. 2011), rev’d and remanded, 963 N.E. 2d 463 (Ind. 2012). The taxpayer was a corporation operating rent-to-own retail stores in Indiana. As part of an affiliated group and under the guidelines established in an independent transfer-pricing study, Rent-A-Center East paid royalties and compensation for strategic management services to other members of the group without ties to Indiana. Rent-A-Center East filed its 2003 tax return in Indiana on a separate-company basis, as mandated by statute, reporting no tax due. Upon auditing the return, the Department of Revenue concluded that the corporation’s tax return did not fairly represent its income from Indiana sources. It proposed an assessment requiring the taxpayer to report its tax liability using a combined income tax return with two of its affiliates.

The Indiana statute incorporated a provision on alternative apportionment. It adopted language substantially similar to the UDITPA formula, granting the department authority to require departure from its standard allocation and apportionment provisions when they do not “fairly represent the taxpayer’s income derived from sources within the state of Indiana” (Ind. Code §6-3-2-2(l)). In addition, the department’s authority to require combined reporting was further limited by the statute, which provided that a combined report could not be mandated “unless the department is unable to fairly reflect the taxpayer’s adjusted gross income . . . through use of other powers granted to the department” under the other allocation and apportionment provisions (Ind. Code §6-3-2-2(p)).

According to the Indiana Tax Court, the statutory language required the department to present facts to prove that (1) the taxpayer’s return as filed did not fairly reflect income from Indiana sources; (2) the use of a combined return was reasonable and equitable; and (3) the department had exhausted all of the alternative methodologies available under the statute to determine the income attributable to the state. When the Department of Revenue asked for summary judgment, the Tax Court found that the department failed to present evidence that it considered all alternatives to assessing tax based on a combined return, and the court rejected the additional assessment.

On appeal, however, the Indiana Supreme Court presented a different reading of the statute and the procedural rules. In the Supreme Court’s view, the language of the provisions dealing with alternative methodologies does not impose on the department a standard higher than in any other type of assessment. Under the general powers granted to the department, “the notice of proposed assessment is prima facie evidence that the department’s claim for the unpaid tax is valid. The burden of proving that the proposed assessment is wrong rests with the person against whom the proposed assessment is made” (Ind. Code §6-8.1-5-1(c)). The Supreme Court found that these general powers should not be subject to any particular constraint or higher burden of proof even when used to require a departure from the standard rules. Thus, the assessment itself is prima facie evidence that an alternative method is required and appropriate, and the burden shifts to the taxpayer to prove the contrary.


The Rent-A-Center East decision exemplifies the multistate taxpayer’s concerns over states’ aggressive use of the alternative apportionment mechanism. Debating the fairness of standard apportionment schemes is a very difficult task. Preserving the presumptions in favor of the state when it seeks to override the statutory apportionment schemes and shifting the burden of proof to the taxpayer will continue to give state tax authorities an unfair advantage and place an undue burden on multistate businesses whether they are seeking an alternative apportionment method, or defending against a method forced upon them by the state.

Also, contrary to the holding of the Indiana Supreme Court, requiring a modified procedural standard to support departures from the general methodologies seems appropriate to preserve the exceptional character of such provisions. Rules and policies for allocation and apportionment are enacted through legislation and formal rule-making, ensuring certainty and consistency of treatment for multistate corporations. Alternative apportionment provisions are intended as a last resort—available to both the taxpayer and the department—when all the standard methodologies have failed. Absent any restriction on the discretionary authority of the state revenue departments, alternative apportionment may become instead a “catch-all” tool employed by the departments to override statutory provisions and seek additional tax assessments on an ad hoc, after-the-fact basis.


Alan Wong is a senior manager at Holtz Rubenstein Reminick LLP, DFK International/USA, in New York City.

For additional information about these items, contact Mr. Wong at 212-697-6900, ext. 986 or

Unless otherwise noted, contributors are members of or associated with DFK International/USA.

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