Alabama Department of Revenue Proposes Changes to its Corporate Income Tax Apportionment Regulations

State & Local Tax Alert: Alabama Edition

Client Alert

The Alabama Department of Revenue (ADOR) recently proposed numerous changes to its apportionment rules for corporate income taxpayers, with the stated intention of adopting “recommended amendments to the [Multistate Tax Commission (MTC)] Rules approved by the MTC Executive Committee.” The public hearing on these proposed rules is set for 2 p.m. on Thursday, February 11 at ADOR headquarters. Comment letters must be submitted at or before the hearing. A copy of the proposed rules and the related notice of proposed rulemaking is available here.

The proposed changes are extensive. It is difficult to highlight all the changes because the Department has also proposed to repeal the existing rules due to an incorrect Legislative Reference Service numbering format. Thus, the proposed changes are not amendments but instead styled as “new rules,” and there is no blackline version or summary of the changes other than the statement above regarding the MTC uniformity rules. Oddly, the ADOR’s economic impact statement concludes there will be no economic impact (i.e., no revenue increase) from the adoption of the rules.

The proposed changes include expanding the payroll factor to include leased or temporary employees in certain cases, adopting all of the MTC specific-industry rules for alternative apportionment, requiring a taxpayer to petition at least six months in advance of filing its return in order to request alternative apportionment, and conforming the definition of business income with the 2001 legislative change to the statute. A summary of these and other changes is provided below:

1. Definition of “Business Income” – The ADOR rules are updated to include the legislative changes in 2001 that overruled the Alabama Supreme Court’s decision in Uniroyal and to adopt the transactional, functional, and new “operationally related” test for business income.

(a) Unfortunately, all examples applying the business versus non-business income rules are deleted, which is inconsistent with the counterpart MTC rule.

(b) Thankfully, the ADOR did not attempt to overrule Tate & Lyle Ingredients Americas, Inc. v. ADOR (2008), involving the sale of stock of a subsidiary and whether the gain on that sale was business income. Both the Administrative Law Division and the Montgomery County Circuit Court found the gain was non-business income because the parties were non-unitary.

(c) The proposed rule deletes the “state-to-state” consistency requirement with respect to business income, while retaining that requirement in the property and payroll factor rules.

2. Changes to the Property Factor Rule – These changes generally track the MTC uniformity rule, but we nevertheless highlight the material differences between the existing ADOR rule and the proposed rule.

(a) In terms of valuing rental property, the proposed rule adds details to examples two and three to further distinguish between business and non-business income.

(b) The proposed rule adds that capitalized intangible drilling and development costs are included in the property factor.

(c) The proposed rule provides that in valuing rental property, royalties from the extraction of natural resources are excluded from “annual rental.”

3. Changes to the Payroll Factor Rule – The proposed rules include several changes to the payroll factor that do not currently conform with the MTC uniformity rule, including the addition of leased employees in the factor. This change was likely prompted by the Administrative Law Division ruling in C&D Chemical Products, Inc. v. ADOR (2001), approving the taxpayer’s argument that compensation paid (indirectly) to leased employees of an affiliate is included in the payroll factor of the lessee-affiliate, not the putative employer.

(a) The proposed rule states that compensation paid to leased employees shall be included in the payroll factor of the lessee (although the compensation is usually paid indirectly by the lessee) and also provides guidance for “temporary” employees.

(b) The proposed rules are inconsistent with respect to whether payments to leased employees are also included in the payroll factor of the employee leasing company. There could be a double-accounting of compensation if they are included in both.

(c) The proposed rule gives the Alabama Commissioner of Revenue the power to adjust the payroll factor to “prevent distortion . . . if there is evidence that a related member’s employees provided services to or maintained the property of a taxpayer and the payroll factor is inconsistent with the other components of the apportionment factor.” We did not find a similar provision in the MTC uniformity rule.

4. Changes to the Sales Factor Rule – The proposed rule reflects the statutory change in 2011 to adopt double-weighting for the sales factor, along with market-based sourcing.

(a) The proposed rule deletes the “taxable in another state” test currently found in Rule 810-27-1-4-.03 (MTC Regulation IV.3), which previously provided guidance for the application of Alabama’s throwback rule.

(b) The proposed rule deletes the “state-to-state” consistency requirement for including or excluding gross receipts for the sales factor.

(c) The proposed rule adopts the current ADOR rule for sales other than tangible personal property, rather than the MTC’s proposed amendments currently under review by its Executive Committee.

5. Changes to the Section 18 Rules – The proposed rule includes an Alabama-specific procedure for taxpayers to request an alternative apportionment method. If these rules are finalized in their present form, taxpayers must submit a request for alternative apportionment at least six months prior to the due date of the return. As a result, taxpayers will not be able to study and assess the need for alternative apportionment if a tax return has already been filed or if it is within the six month window prior to the due date of the return. And attaching the request to the return, or simply noting the change in method in the return, will not prevent the ADOR from challenging the alternative method.

(a) One of the more troubling aspects of the proposed rules is how they handle special industry rules. Alabama currently has six special industry rules: construction, railroads, airlines, trucking companies, TV and radio broadcasting, and publishing. The proposed rules delete these special rules in their entirety and simply adopt the MTC special industry rules by reference, which we assume would include the more recently issued telecommunications industry rule. It is unclear whether this is a rolling adoption and the ADOR rules will automatically pick up future changes to their MTC counterpart rules or if the reference intends to adopt the MTC rules as currently in effect.

(b) The potential impact on the telecom industry of the adoption of the MTC special rule is unknown.

(c) Other material changes include the deletion of the incidental or occasional sales exception on which many taxpayers have relied in the past.

(d) Consistent with the MTC model rule, at least in most respects, the proposed rule addresses the “liquid” assets and treasury function issue, in response to Microsoft v. California FTB. However, the proposed rule does not include examples.

If you have any questions regarding the proposed changes to the apportionment rules, feel free to contact any of the Alabama members of our SALT Practice Group.