Comments on Proposed New Alabama Corporate Income Tax Apportionment Rules

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] Rules approved by the MTC Executive Committee.” A copy of the Proposed New Administrative Rule 810-27-1 (the “Rule”) and the related notice of proposed rulemaking is available here.

The ADOR held a public hearing on the proposed rules on Thursday, February 11 in Montgomery. Written comments were submitted by the Council On State Taxation (COST), the Alabama Society of CPA’s State Tax Committee, and our law firm. The body of our comment letter is reproduced below and a copy of the COST letter is available here.

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This letter is submitted to you in your capacity as Secretary of the Alabama Department of Revenue and in response to the Department’s publication of Proposed New Administrative Rule 810-27-1 and subparts (collectively, the “Rule”). The proposed Rule was published in the Alabama Administrative Monthly on December 31, 2015 and a public hearing is presently set for February 11. The Rule addresses Alabama’s version of the Multistate Tax Compact, Ala. Code § 40-27-1 et seq. (the “Compact”), which governs the apportionment and allocation of income for corporate income tax purposes. We apologize for the late day of delivery of this letter but we are still receiving input and questions from our multistate clients.

The stated intent of the Rule is “to reflect the correct LRS rule numbering format and recommended amendments to the MTC rules approved by the MTC Executive Committee.” While the MTC has considered, completed and is currently pursuing several uniformity projects with respect to the Compact and the related model regulations, the MTC models can only be applied to the extent they are consistent with the version of the Compact as adopted and amended by the Alabama Legislature. We respectfully submit the following comments and requests for additional information on the changes included in the proposed Rule:

1. The time period for requesting alternative apportionment should apply to all open tax periods: The proposed Rule includes a new pre-clearance procedure for taxpayers to request an alternative apportionment method, which is not present in the current MTC model regulations. The proposed Rule provides that taxpayers must submit a request for alternative apportionment at least six months prior to the due date of their tax return. As a result, taxpayers will not be able to study and assess the need for alternative apportionment if a return has already been filed or if it is within the six-month window prior to the due date of the return. As explained in the excellent comments filed by the Council On State Taxation (“COST”), we believe that the Rule should be revised to delete the six-month time limitation in its entirety, not only because it is inconsistent with the MTC counterpart but because it will create a strong impediment to taxpayers who may be entitled to alternative apportionment.

2. The special industry rules should be separately included in the Rule, verbatim, and not adopted by reference to their MTC counterparts. Alabama currently has six special industry rules: construction; railroads; airlines; trucking companies; TV and radio broadcasting; and publishing. The proposed Rule deletes these special rules in their entirety and simply adopts the MTC special industry rules by reference, which we assume would include the more recently-issued telecommunications industry rule. We would appreciate clarification of that fact. It’s unclear whether this cross-reference is intended as a rolling adoption, such that the Rule would attempt to automatically incorporate future changes to the MTC counterpart as and when those rules are finalized (or perhaps some other date), or if the reference is meant only to adopt the MTC rules as currently in effect.

There are several problems with either approach--some legal and some practical-- including the issues raised by COST with respect to the nature of the MTC counterparts as a “model” rule. A rolling adoption by reference to future changes to be proposed and adopted by the MTC doesn’t comply with the incorporation-by-reference procedures required by the Alabama Administrative Procedure Act (“AAPA”), which provides in pertinent part:

An agency may adopt, by reference in its rules and without publishing the adopted matter in full, all or any part of a code, standard or regulation which has been adopted by any other agency of this state or any agency of the United States or by a generally recognized organization or association approved by the joint committee administrative regulation review. The reference shall fully identify the adopted matter by date and otherwise.

Ala. Code § 41-22-9 (emphasis added).

Additionally, the Department’s adoption of the MTC special industry rules by reference could imply that the Department believes taxpayers have the right to elect an evenly-weighted three factor formula under Alabama’s version of the Compact, because the examples in the MTC model rule indeed use an equally-weighted three factor formula. It’s our understanding that the Department has taken positions on audit that the alternate election is not allowed under Alabama’s amended version of the Compact, and thus the proposed Rule creates another layer of uncertainty as to the apportionment formulas available under Alabama law.

Finally, as a matter of taxpayer convenience and compliance, taxpayers and their advisers should be able to locate all relevant corporate income tax rules in one place, on the Department’s website, and not have to seek other rules on an MTC or other website, coupled with the uncertainty whether the MTC rules on its or another website are actually the versions currently applicable to Alabama taxpayers.

3. The leased employee should only be included in the payroll factor of the lessee or lessor, not both. The proposed rules are inconsistent with respect to whether compensation paid to or for leased employees are also included in the payroll factor of the employee leasing company. If they are included in both, this could lead to distortion in both the numerator and the denominator by double-counting the same compensation.

4. The discretionary power to adjust the payroll factor with respect to intercompany services should be deleted. The proposed Rule gives the Commissioner of Revenue the special 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.” This provision should be deleted for several reasons, including the reasons provided by COST. First, the Commissioner’s power to prevent distortion from abusive related party transactions is codified in Ala. Code § 40-2A-17(a), and has more specific standards or bases. Second, there is no corollary to this provision in the MTC model apportionment rule, which is the stated intent of the proposed Rule. Finally, the proposed Rule, as applied, may exceed the authority granted to the Commissioner under either the Compact or Ala. Code § 40-2A-17(a).

5. Explanation for variances from MTC model regulations. As noted above, the MTC model statutes and rules can only apply to the extent they are consistent with Alabama’s version of the Compact, including the (a) amendment to the definition of ‘business income’ in 2001 after the Alabama Supreme Court’s Uniroyal decision and (b) amendments to double-weight the sales factor and adopt market-based sourcing for services and intangibles in 2011. Because the Rule was proposed as a new rule to correct the LRS numbering format, instead of an amendment to an existing rule (that would be blacklined to highlight the changes), the only guidance regarding the scope of the proposed changes is the statement that they are intended to adopt “recommended amendments to the MTC rules.” As illustrated below, there are several material changes included in the Rule that are not included in the MTC model regulations and there may be others that we simply could not identify due to lack of time.

The Department should provide taxpayers with adequate guidance and transparency as to the reason for the changes included in the Rules, especially those changes that are inconsistent with the MTC model rules, such as:

• Deletion of all examples applying the business versus non-business income rules;
• Deletion of the “state-to-state” consistency requirement with respect to the definition of business income and the sales factor, while retaining that requirement in the property and payroll factor rules;
• Deletion of the “taxable in another state” rule that provides guidance for when apportionment is allowed and the applicability of Alabama’s throwback rule;
• Ability of the Department to adjust the payroll factor regarding services performed by related parties;
• Requiring taxpayers to submit alternative apportionment requests at least six months prior to the due date of the return; and
• Deletion of the Special Rule excluding incidental or occasional sales from the sales factor.

We are aware of the reasoning behind the inclusion of leased employees in the payroll factor in light of the Administrative Law Division’s ruling in C&D Chemical Products vs. ADOR, but the above list is likely not an exhaustive account of the changes included in the proposed Rule. It merely illustrates certain of the variances from the MTC model rules. It would very helpful to taxpayers (and their advisers) if the Department quickly published a summary of those changes and the reasoning behind each.

6. Economic impact of the Rule : Given the substantial number of changes included in the proposed Rule, we were surprised by the Department’s assessment that the Rule will not have any economic impact. Perhaps the Department believes that any increases to taxpayers’ Alabama income tax liability by increased apportionment factors, or denial of their request for a more favorable apportionment formula, will be offset by decreases to other taxpayers’ liability, which seems to be the only way the proposed Rule would not have any economic impact. This seems unlikely, particularly in light of the three changes/disconformities noted in the COST comment letter and other material changes noted above. We would appreciate an explanation for this revenue estimate.