Special apportionment rules for manufacturers
MANUFACTURING INSIGHTS |
Since its approval in 1957, states have utilized the Uniform Division of Income for Tax Purposes Act ("UDITPA") as a model system for apportioning the income of multistate businesses. Intended to promote uniformity among the states and to mitigate the over- or under-taxation of interstate income, UDITPA apportions business income using an equally-weighted three-factor formula that compares the ratio of a taxpayer's in-state sales, property and payroll to its total sales, property and payroll.1 However, UDITPA's approach to apportionment was designed for a manufacturing-based national economy, and the ongoing shift to a service-driven national economy has led to significant concern that, in all too many cases, the UDITPA standard apportionment formula fails to reasonably reflect the source of income.
In response to this perceived disconnect between UDITPA and the modern economy, various organizations and states in their separate capacities have launched reform efforts focusing on the continued reasonableness of the UDITPA apportionment formula. To date, these efforts have had uneven results, as reflected in the proliferation of double-weighted sales and single sales factor apportionment formulas, expansion of the use of state alternative apportionment powers, and numerous and varied changes in how states source sales of services and intangibles. In some states, however, this effort has led to the enactment of special apportionment rules for manufacturers, the very businesses for which the UDITPA apportionment formula was designed.
At present, Connecticut,2 Kansas,3 Louisiana,4 Maryland,5 Massachusetts,6 Mississippi,7 New Mexico,8 Oklahoma,9 Rhode Island,10 and Virginia,11 have enacted special apportionment rules applicable to manufacturers. Other than Mississippi, these rules share a common conceptual thread. UDITPA's equally-weighted three factor formula emphasizes the location in which manufacturing activities are performed over the location where manufactured goods are sold. Thus, from a single state perspective, in-state manufacturers are subject to an apportionment-based competitive disadvantage because the weight of the property and payroll factors in the total apportionment formula drive up post-apportionment taxable income in relation to similarly situated out-of-state manufacturers. To offset this competitive disadvantage, the weight of the sales factor must be increased.12
Although the policy considerations involved in the creation of a special apportionment rule for manufacturers are substantially similar in most of the states in question, implementation of the common solution varies. Therefore, a business that qualifies as a manufacturer in one state may not be a manufacturer in another, and differences between each state's standard apportionment formula and special apportionment formula for manufacturers may produce benefits or detriments depending on both the state in question and the facts and circumstances involved. Additionally, some states' special apportionment rules for manufacturers are elective, may require additional reporting, and could be subject to a phase-in period. Lastly, in some states, benefits obtained from the use of a special apportionment rule for manufacturers may be subject to recapture if the manufacturer does not meet certain property and payroll thresholds.
Exploring these issues for some of the states in question is illustrative of the opportunities and pitfalls involved in apportioning the income of manufacturers in the states in question. For example:
- Connecticut: Connecticut generally sources income derived from the manufacture, sale or use of tangible or real property using a three factor apportionment formula with a double-weighted sales factor.13 However, a manufacturer classified in North American Industrial Classification System (NAICS) Sectors 31, 32 and 33 must use a single sales factor formula unless the manufacturer makes 75 percent or more of its sales to the United States government, at which point the manufacturer may elect to use either apportionment formula.14
- Massachusetts: Massachusetts generally sources income using a three factor apportionment formula with a double-weighted sales factor.15 However, single sales factor apportionment is used to source the income of manufacturers.16 To qualify as a manufacturer, a taxpayer must be engaged, in substantial part, in transforming raw or finished physical materials into a new product with a new name and nature and adapted to a new use.17 A taxpayer's manufacturing activities are substantial if they meet certain specified thresholds.18 For example, a taxpayer's manufacturing activities are substantial if 25 percent or more of the taxpayer's gross receipts are derived from the sale of goods that the taxpayer has manufactured.19 Other possible thresholds include a mixed payroll and receipts standard,20 a mixed property and receipts standard,21 and a standard based on property alone.22 Outside of the qualification requirements, a manufacturer that has more than 25 employees must submit an annual report attached to its Massachusetts corporate tax return providing information including the number of jobs added or lost, changes in the property factor, changes in the payroll factor, and tax revenue that would have been due if the manufacturer did not qualify to use the single sales factor apportionment formula.
- Virginia: Virginia generally sources income using a three factor apportionment formula with a double-weighted sales factor.23 For taxable years starting on or after July 1, 2011 until July 1, 2013, a manufacturer classified in NAICS Sectors 11, 31, 32 and 33 may elect to use a triple-weighted sales factor, and, for taxable years starting on or after July 1, 2013 until July 1, 2014, a manufacturer may elect to use a triple-weighted sales factor.24 For tax years starting after July 1, 2014, a manufacturer may elect to use a single sales factor formula.25 The election to use the above apportionment rules applicable to manufacturers is binding for three years, and is dependent upon the taxpayer's certification that the average weekly wage of its full-time employees is greater than the lesser of the state or local average weekly wages for the taxpayer's industry.26 If, within the first three years after making the election, a manufacturer's number of full time employees drops below 90 percent of first year employment or the average wage of full-time employees falls below the required level, the manufacturer would be required to pay the additional tax that would have been due if it had not made the election, plus penalties and interest.27
In conclusion, manufacturers should be aware that a number of states provide special apportionment rules that may be applicable to their business. However, as can be seen from the three states discussed above, significant state-to-state variations exist in regard to which taxpayers qualify for manufacturer-specific apportionment and how the rules are applied. Accordingly, manufacturers should analyze the applicability of these rules on a state-by-state basis, and closely consider the opportunities and pitfalls involved.
For further information, please contact Brian J. Kirkell, Director, McGladrey.com.
1UDITPA Sec. 9. 2Conn. Gen. Stat. Sec. 12-218(c) and (k). 3Kan. Stat. Ann. Sec. 79-3729(b)(6). 4 La. Rev. Stat. Ann. Sec. 47:287.95(F). 5 Md. Code Ann. Tax-Gen. Sec. 10-402(c); Md. Regs. Code Sec. 03.04.03.10. 6 Mass. Gen. L. Chapter 63 Sec. 38(l); 830 CMR 63.38.1(10).
7 Miss. Admin. Code Sec. 35.III.8.06. 8 NMSA 1978 Sec. 7-4-10; N.M. Admin. Code Sec. 126.96.36.199(B). 9Okla. Stat. 68 Sec. 2358(A)(4)(d). 10 R.I. Gen. Laws Secs. 44-11-14.1 and -14.6; R.I. Reg. CT 04-04. 11 Va. Code Ann. Sec. 58.1-422. 12 Interestingly, Mississippi takes the opposite approach, adopting a single sales factor formula as the standard apportionment method, and, through regulations, requiring manufacturers to utilize a three factor formula subject to variations depending on the nature of the manufacturer's primary business activities.
13 Gen. Conn. Stat. Sec. 12-218(c). 14 Gen. Conn. Stat. Sec. 12-218(k). 15 Mass. Gen. L. Chapter 63 Sec. 38(c). 16 Mass. Gen. L. Chapter 63 Sec. 38(l)(1). 17 Mass. Gen. L. Chapter 63 Sec. 38(l)(1); 830 CMR 63.38.1(10)(b). 18 Id. 19 Mass. Gen. L. Chapter 63 Sec. 38(l)(1)(1); 830 CMR 63.38.1(10)(b)(2)(a). 20 Mass. Gen. L. Chapter 63 Sec. 38(l)(1)(2); 830 CMR 63.38.1(10)(b)(2)(b). 21 Mass. Gen. L. Chapter 63 Sec. 38(l)(1)(3); 830 CMR 63.38.1(10)(b)(2)(c). 22Mass. Gen. L. Chapter 63 Sec. 38(l)(1)(4); 830 CMR 63.38.1(10)(b)(2)(d). 23 Va. Code Ann. Sec. 58.1-408. 24 Va. Code Ann. Sec. 58.1-422(A). 25 Id. 26 Va. Code Ann. Sec. 58.1-422(B). 27 Va. Code Ann. Sec. 58.1-422(C).