State & Local Tax Alert Breaking state and local tax developments from Grant Thornton LLP South Carolina Holds Electric Utility Company Is Manufacturer, Gross Proceeds Not Includable in Sales Denominator The South Carolina Court of Appeals has upheld an administrative law court (ALC) decision holding that a taxpayer engaged in the production of electricity was a manufacturer required to use a three-factor apportionment formula, and that gross receipts from the sale of short-term investments should be excluded from the denominator of the sales factor. 1 Background The taxpayer generates, transmits, distributes and sells electricity to customers located in North and South Carolina. A portion of the electricity sold is produced at multiple power plants located in South Carolina. For tax years 1978-2001, the taxpayer filed original South Carolina income tax returns on a timely basis using a three-factor apportionment formula required of manufacturers for those tax years. In December 2002, the taxpayer filed amended South Carolina returns asserting that it was not a manufacturer and therefore should have used a single sales factor for apportionment purposes. The taxpayer also amended the returns to include gross receipts from sales of certain shortterm investments in the denominators of its sales factors. The taxpayer s refund claim requested over $126 million in tax, in addition to interest. The Department of Revenue denied the refund requests and the taxpayer appealed to the Department s Office of Appeals in March 2003. The Department took no action until it denied the appeal in February 2010. In response to the denial, the taxpayer filed a contested case in the ALC, which addressed three issues: (i) whether the taxpayer s original refund claims were filed on a timely basis; (ii) whether the taxpayer was required to use the three-factor apportionment formula as a manufacturer; and (iii) whether the taxpayer could include in the denominator of its sales factor its gross receipts from sales of certain short-term investments. The ALC found that the taxpayer: (i) filed untimely refund claims for tax years 1978-1993; (ii) was required to use the three-factor apportionment formula; and (iii) could not include gross receipts from the sale of certain short-term investments in the denominator of its sales factor. 2 The taxpayer appealed this decision to the Court of Appeals. Release date November 25, 2014 States South Carolina Issue/Topic Corporate Income Tax Contact details Michael Boykin T 704.632.3910 E michael.boykin@us.gt.com Tom Coley T 704.632.6827 E tom.coley@us.gt.com John Ward T 704.632.6912 E john.ward@us.gt.com Jenny Wagner T 704.632.3983 E jenny.wagner@us.gt.com Jamie C. Yesnowitz Washington, DC T 202.521.1504 E jamie.yesnowitz@us.gt.com Chuck Jones Chicago T 312.602.8517 E chuck.jones@us.gt.com Lori Stolly Cincinnati T 513.345.4540 E lori.stolly@us.gt.com www.grantthornton.com/salt 1 Duke Energy Corp. v. South Carolina Department of Revenue, South Carolina Court of Appeals, Case No. 2012-213180, Oct. 8, 2014. 2 Duke Energy Corp. v. South Carolina Department of Revenue, South Carolina Administrative Law Court, Docket No. 10-ALJ-17-0270-CC, Dec. 4, 2012..
Grant Thornton LLP - 2 Apportionment Formula Taxpayers doing business in multiple states including South Carolina are required to use an apportionment formula to determine the amount of South Carolina income tax due. 3 For the tax years at issue, South Carolina provided for the use of two different apportionment formulas. A three-factor apportionment formula with double-weighted sales applied to taxpayers whose principal business in South Carolina was manufacturing or any form of collecting, buying, assembling, or processing goods and materials within South Carolina or selling, distributing, or dealing in tangible personal property within South Carolina. 4 Alternatively, taxpayers whose principal business activity did not meet the definition of manufacturing were required to apportion income using a single sales factor apportionment formula based on gross receipts. 5 Generally, this formula was applicable for taxpayers whose principal business activity was related to intangible property, the provision of services, or by default any other business activity not meeting the definition of manufacturer or distributor and to which no other special apportionment methodology was prescribed. The primary issue in this case related to the classification of the taxpayer s principal business activity in South Carolina and the applicable apportionment formula used in the computation of South Carolina taxable income. The taxpayer asserted that its principal business activity in South Carolina was not manufacturing and therefore, a single sales factor apportionment formula was required. Prior to 2007, taxpayers who qualified as manufacturers were required to use a three-factor apportionment formula with a double weighted sales factor. 6 For tax years 2007 through 2010, taxpayers whose principal activity in the state consisted of manufacturing or distribution were subject to a phased-in single sales factor formula for apportionment purposes. 7 Currently, all taxpayers must apportion their income to South Carolina based on a single sales factor apportionment formula computed by dividing gross receipts from business in South Carolina by total gross receipts for a given period. 8 The taxpayer asserted that it was not a manufacturer as it did not manufacture or distribute tangible property. Although the term manufacturing is not specifically defined by South Carolina, the ALC had found that the taxpayer s business activity met the ordinary definition of the word. The ALC came to that conclusion by noting that the taxpayer used various inputs and a mechanical process to produce electricity, an output that did not 3 S.C. CODE ANN. 12-6-2210(B). This section was enacted in 1995 via Act No. 76. Prior to tax year 1996, apportionment of a multistate taxpayer s income was governed by the predecessor to this section, S.C. CODE ANN. 12-7-250 (1976). Though the wording was slightly different, both sections effectively impose apportionment of multistate income. The state corporation income tax due is computed based upon the taxpayer s taxable income multiplied by its South Carolina apportionment factor. 4 S.C. CODE ANN. 12-6-2252 (previous version). Enacted in 2007, this section contains language identical to its multiple predecessors which applied to earlier tax years. The three factors include property, payroll, and sales factors. 5 S.C. CODE ANN. 12-6-2290. This statute was enacted in 1995 via Act No. 76, and amended in 2007 by Act No. 110. 6 S.C. CODE ANN. 12-6-2250. 7 Revenue Ruling #09-15, South Carolina Department of Revenue, Nov. 1, 2009. 8 S.C. CODE ANN. 12-6-2252(A).
Grant Thornton LLP - 3 previously exist. That output was then sold and delivered to customers for a fee. As such, electricity was considered to be manufactured. The Department also referenced a 1930 South Carolina Supreme Court case involving the same taxpayer in which the taxpayer prevailed in seeking the classification of its power plants as manufactories, thus exempting them from county property taxes. 9 Relying upon the evidence provided at the ALC level, as well as legislative intent to impose the South Carolina income tax upon a base which reasonably represents the proportion of trade or business carried on in South Carolina, the Court affirmed the decision. Specifically, the Court ruled that the taxpayer was considered a manufacturer for purposes of determining the methodology for apportioning income to the state and that the threefactor apportionment formula was required for the disputed tax years. The Court rejected the taxpayer s argument that as a producer of electricity, an arguably intangible item, the taxpayer could not be considered a manufacturer under the South Carolina statute. In addition, the Court concluded that the taxpayer s principal business was that of a manufacturer and not a service provider, which would have resulted in the single sales factor treatment requested by the taxpayer. Gross Receipts With respect to the taxpayer s position that gross receipts from sales of the taxpayer s short-term investment instruments could be included in the denominator of its sales factor, the Court looked closely to the definition of gross receipts, and the nature of the specific receipts earned by the taxpayer. South Carolina generally defines gross receipts to include the following if related to ordinary business activities: Receipts from the sale or rental of property; Receipts from the sale of accounts receivable; Receipts from the use of intangible property; Net gain from the sale of property; Receipts from services if the entire income-producing activity is within South Carolina; and Receipts from the sale of intangible property. 10 The taxpayer classified the investments at issue as intangible property and included the gross receipts from the sales of these investments in the denominator of the amended sales factor. This classification substantially reduced the taxpayer s overall South Carolina sales factor percentage. The Department, however, reasoned that when the taxpayer invests its business proceeds in short-term financial instruments and subsequently sells the investment for a profit, only the profit generated is considered a receipt includable in the sales factor denominator, not the return of the principal used to purchase the investment. Finding that the return of principal is not a receipt, the Court agreed, affirming the ALC s decision that the gross receipts from the sale of short-term investments cannot be included in the denominator of the sales factor for apportionment purposes. 9 Duke Power Co. v. Bell, 152 S.E. 865 (S.C. 1930). 10 S.C. CODE ANN. 12-6-2295.
Grant Thornton LLP - 4 Statute of Limitations Although the timeliness of the refund claims was not considered as a result of the Court s disposition of the above substantive issues, it is worth noting that South Carolina does have specific limitation periods in which refund claims must be filed. Generally, the statute of limitation period for filing a refund claim in South Carolina is the later of three years from the date the original return was filed or two years from the date the liability was paid. 11 Commentary In its findings, the Court clearly demonstrated its full support of the Department s position with respect to classification of the taxpayer as a manufacturer. The intangible nature of a product manufactured does not itself cause the producer to be classified as a service company, particularly where provision of the service is not the producer s primary business activity. It is notable that the Court considered legislative intent in support of its affirmation, stating that income tax should be based on income which reasonably represents the amount of business done within the state. This idea of fair representation, legislative intent and alternative intent can also be seen in other recent cases in the Southeast. 12 Unfortunately, due to South Carolina s adoption of single-sales-factor apportionment for all taxpayers beginning in 2007 and phased-in through 2010, opportunities for other manufacturers of intangible products who originally filed South Carolina income tax returns using the single-sales-factor apportionment methodology for other-thanmanufacturing and who might benefit from a three-factor formula on amended returns are likely limited by statute. Taxpayers that have represented receipts from short-term investments on a gross instead of net basis for purposes of the South Carolina sales factor may need to amend returns that are still open under the South Carolina statute of limitations, resulting in an exposure item or potential refund opportunity depending upon specific facts and circumstances. It should be noted that opportunities may exist for taxpayers with significant losses in years outside the statute of limitations to adjust South Carolina net operating loss carryforwards if the adjustments resulting from the Court s findings cause an increase to the originally reported apportionment factor. Additionally, as several South Carolina income tax credits are limited to taxpayers in specific industries, including manufacturing, certain credits may now be available to taxpayers that previously presumed themselves excluded from the definition of manufacturer. 11 S.C. CODE ANN. 12-60-470. 12 For example, Vodafone Americas Holdings Inc. v. Roberts, Tennessee Court of Appeals, No. M2013-00947-COA-R3-CV, June 23, 2014. In this decision, the Court focused on the need for an apportionment method to fairly represent the taxpayer s business in Tennessee and ruled that the state s imposition of an alternate apportionment method to accomplish this was allowable. See also Wal-Mart Stores East, Inc. v. Hinton, 676 S.E.2d 634 (N.C. Ct. App. 2009).
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