Final Written Determination

Docket Number:WFD-P-2007-1
Tax Type:Corporate Income Tax
Brief Description:Final assessment of corporate income tax.
Approval Date:01/08/2007


January 8, 2007

RE: Request of XXXX for an Informal Conference to Reconsider Agency Action, Docket No. 04-0200.

Dear XXXX:

On May 28, 2004, you timely requested an informal conference with the Kansas Secretary of Revenue. You sought review of the facts and issues that underlie the department's April 1, 2004 final assessment of corporate income tax. That assessment schedules a deficiency of $12,407.00 in tax, penalty, and interest. Your hearing request lists four objections to the assessment. The third one states:

Historically, the department has put forth two alternate arguments to support its treatment of gross investment proceeds. One is that while recycled investment capital satisfies the definition of "gross receipts," K.S.A. 79-3288 allows the department to adjust the resulting apportionment formula because it fails to "fairly represent the extent of the taxpayer's business activities in [Kansas]." The alternate is that receipts from investment capital generated by churning or recycling do not constitute "gross receipts" under the Uniform Division of Income for Tax Purposes Act (UDITPA) and therefore need not be included in the formula denominator. Both arguments are supported by case law from other jurisdictions.

Recently, the California Supreme Court published two cases that deal with gross investment proceeds under UDITPA: Microsoft Corporation v. Franchise Tax Board, 39 Cal. 4th 750, 139 P.3d 1169 (2006), and General Motors Corporation v. Franchise Tax Board, 39 Cal. 4th 773, 139 P.3d 1183( 2006). Kansas is a UDITPA state. These two cases provide compelling support for the department's argument that while recycled investment capital meets the definition of "gross receipts," the resulting apportionment formula may be adjusted under UDITPA because it fails to "fairly represent the extent of the taxpayer's business activities in this state." Compare Cal. Revenue & Tax Code Sec. 25137 with K.S.A. 79-3288, which contains the same UDITPA language as Sec. 25137.

The Microsoft decision begins by summarizing the Supreme Court's holding about how the UDITPA applies to "gross investment proceeds" like those of the taxpayer here --- XXXX Corporation & Subsidiaries (XXXX):
The United States Constitution bars taxation of extraterritorial income. (Citations omitted). However, it permits taxation of “an apportionable share of the multistate business carried on in part in the taxing State” (Citations omitted) and grants states some leeway in separating out their respective shares of this multistate income, not mandating they use any particular formula (Citations omitted). One constitutional method of apportionment, the unitary business/formula apportionment method, “calculates the local tax base by first describing the scope of the ‘unitary business' of which the taxed enterprise's activities in the taxing jurisdiction form one part, and then apportioning the total income of that ‘unitary business' between the taxing jurisdiction and the rest of the world on the basis of a formula taking into account objective measures of the corporation's activities within and without the jurisdiction.” (Citations omitted). The UDITPA is generally based on this method. (Citations omitted).

Under the UDITPA, a unitary enterprise's income is divided into “business income” and “nonbusiness income.”(Citations omitted). With some exceptions, nonbusiness income is generally allocated directly to the taxpayer's domiciliary state. (Citations omitted). In contrast, business income is apportioned among the states according to a formula. The portion of a taxpayer's business income attributable to economic activity in a given state is determined by combining three factors: payroll, property, and sales. (Citations omitted). Each factor is a fraction in which the numerator measures activity or assets within a given state, while the denominator includes all activities or assets anywhere. (Citations omitted). The combination of these fractions is used to determine the fraction of total global business income attributable to the given state. (Citations omitted). This method provides a rough but constitutionally sufficient approximation of the income attributable to business activity in each state. (Citations omitted).

Only the sales factor is at issue here. The sales factor is a ratio comparing sales in a given state to total sales everywhere. (Citations omitted). Sales are measured by counting a business's “gross receipts.” (Citations omitted). Increases in in-state gross receipts will lead to a larger fraction, greater apportioned income, and higher tax; conversely, increases in out-of-state gross receipts will lead to a reduction in the fraction attributable to California and a reduction in California tax.

The UDITPA contains a relief provision. If application of the foregoing provisions fails to “fairly represent the extent of the taxpayer's business activity in this state,” the taxpayer may seek or the Board may impose an alternate method of calculation to achieve an equitable result. (Citation omitted) . . . .

After summarizing the facts of the case, the California Supreme Court reasons that an adjustment of Microsoft's reporting of its gross investment proceeds is warranted under Cal. Revenue & Tax Code Sec. 25137:

Both Microsoft and General Motors find Cal. Revenue & Tax Code Sec. 25137 to be controlling. Section 25137 is a UDITPA provision that allow an allocation and apportionment formula to be adjusted when the formula fails to "fairly represent the extent of the taxpayer's business activities in this state." K.S.A. 79-3288 contains the same UDITPA language as that California Supreme Court relies on from Cal. Revenue & Tax Code Sec. 25137:
The California decisions provide a sound basis for the department's administrative action of disallowing the inclusion of gross investment proceeds in the 1999 sale factor denominator.

State court decisions that support the alternate argument are cited in the lower court decision that gave rise to General Motors Corporation v. Franchise Tax Board, 39 Cal. 4th 773, 139 P.3d 1183 (2006). In General Motors Corporation v. Franchise Tax Board, 120 Cal. App. 4th 114, 16 Cal. Rptr. 3d 41 (2004), the California Court of Appeals reasoned:
The cases from New Jersey, Indiana, Nebraska, and Tennessee that are cited by the California Court of Appeals are persuasive. This is so even though the California Supreme Court believed the better argument to be that "repos" are required to be included in General Motor's report of its gross receipts. These two alternate theories are the inconsistent since one holds that the taxpayer's gross investment proceeds are gross receipts while the other holds they are not. However, this inconsistency is of no consequence here since the underlying facts support both legal theories, whether inconsistent or not. See Western Machinery Co. v. Consolidated Uranium Mines, Inc., 247 F.2d 685,688-9(10th Cir. 1957), citing Blazer v. Black, 196 F.2d 139, 144 (10th Cir. 1952); see also K.S.A. 2005 Supp. 60-208(e)(2).

The case law show that gross investment proceeds can and do unfairly distort the taxes that are apportioned to a state under UDITPA. Kansas has addressed this problem in the following Instruction found on page 15 of the 2007 Kansas Corporate Income Tax booklet:

These same instructions were published in the 1997 through 2006 Kansas Corporate Income Tax booklets. This means that XXXX had construction knowledge of the department's policy both when it filed its 1999 corporate income return and when it filed amendments to it that the department rejected in the April 1, 2004 final assessment of corporate income tax, which XXXX appeals from.

Audit assessments are generally afforded a presumption of correctness. Portillo v. Commissioner, 932 F.2d 1128, 1133 (5th Cir. 1991); Anastatsato v. Commissioner, 794 F.2d 884, 886 (3rd Cir. 1986) ; United States v. Janis, 428 U.S. 433, 441 (1976); Helvering v. Taylor, 293 U.S. 507, 515 (1935); Welch v. Helvering, 290 U.S. 111, 115 (1933); Baird v. Commissioner, 438 F.2d 490, 492 (3rd Cir. 1970). This procedural scheme means that the department's assessment is presumed to be accurate and correct. Because both alternate legal theories are supported by the same facts and are persuasive, the department's action regarding the treatment of the gross investment proceeds in this appeal is upheld.

A second issue raised by XXXX concerns a adjustment made to disallow the subtraction of $107,886 claimed on its 1999 amended return relating to foreign dividends. Allowing this foreign dividend modification would net a tax reduction for XXXX of approximately $551. My file notes on this issue indicate that additional documentation is needed before this request can be approved. A third issue concerns XXXX's contention that it qualifies for retroactive certificate of HPIP credits in light of the Kansas Court of Appeals' holding in Hallmark Cards, Inc. v. Kansas Department of Commerce and Housing, 32 Kan. App. 2d 715 , 88 P.3d 250 (2004). My file notes indicate that XXXX has asked to withdraw this issue from consideration. XXXX has also requested a penalty waiver. The department has not received sufficient documentation to grant a penalty waiver at this time.

The department acted properly when it issued its April 1, 2004 assessment letter which adjusted XXXX's amended income tax returns. The department's action is upheld for the reasons stated in this order.

This written determination constitutes final agency action subject to administrative review by the Board of Tax Appeals (BOTA). If you wish to appeal this determination you must, pursuant to K.S.A. 74-2438 or 74-2433f, file a notice of appeal with the Secretary of the Board of Tax Appeals within 30 days after the date of this final determination and serve a copy of the notice upon the Secretary of Revenue or her designee. There may be a filing fee for filing with the BOTA. See or call 785/296-2388 for further information. BOTA’s address is Suite 451; Docking State Office Building; 915 Southwest Harrison Street; Topeka, Kansas 66612-1505.


Thomas E. Hatten
Designee of the Secretary of Revenue
cc: Charles Reimer; Pat Verschelden

Date Composed: 01/18/2007 Date Modified: 01/18/2007