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The Significance of the Multistate Tax Compact and UDITPA Amid Recent Developments

May 18th 2016
Editor/Author Thomson Reuters Checkpoint
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On Dec. 31, 2015, in The Gillette Company et al. v. Franchise Tax Board, the Supreme Court of California held that taxpayers could not elect to apportion income under the Multistate Tax Compact. The compact is a model law developed in the 1960s, and joined by California in 1974, to establish uniformity in how states source the income of multistate companies.

Overruling a 2012 decision by the California Court of Appeal, the Gillette court held that, although California had not officially withdrawn from the compact for the tax years at issue, the compact was not binding and the state successfully nullified the compact’s apportionment election when it adopted conflicting provisions in 1993. This key ruling comes on the heels of similar cases in Michigan, Minnesota, Oregon, and Texas, and will likely be appealed to the US Supreme Court.

As a tax professional, understanding the significance of this decision and its impact on each state’s policies is crucial in devising tax-planning strategies and identifying risks for multistate clients. Here, we take a look at the Multistate Tax Compact, the related Uniform Division of Income for Tax Purposes Act (UDITPA), and how the changing economy is influencing the way states are interpreting these laws.

Understanding UDITPA and the Compact
Originally issued in 1957 by the Uniform Law Commission, UDITPA provides a model law for allocating and apportioning income among the states. In 1966, a group of state officials drafted the Multistate Tax Compact, which incorporates UDITPA, to address income tax issues affecting multistate taxpayers. The compact took effect on Aug. 4, 1967, upon adoption by seven states.

UDITPA distinguishes between business and nonbusiness income; requires an evenly-weighted, three-factor apportionment formula; and follows the “cost of performance” sourcing method. From 1967 through 2014, Article IV of the Multistate Tax Compact conformed to UDITPA.

At its annual business meetings in July 2014 and 2015, the Multistate Tax Commission (the body that oversees the compact) adopted several sweeping amendments to Article IV. The revised Article IV adopts a broad “apportionable income” definition, requires market-based sourcing, and recommends use of a three-factor apportionment formula with a double-weighted sales factor.

To date, no state has adopted the revised Article IV, though many states are independently moving to market-based sourcing and apportionment formulas that give greater – or exclusive – consideration to the sales factor.

States’ Multistate Tax Compact Status
The following are results of an October 2015 Thomson Reuters survey, Westlaw 50 State Statutory Surveys: Taxation: Multistate Compacts and Apportionment:

  • Fifteen states and the District of Columbia are members of the Multistate Tax Compact.
  • Seven states are “sovereignty” members.
  • Twenty-six states are “associate” members.
  • Two states are nonmembers.

Sovereignty members. Have not adopted the compact but pledged support for the activities of the Multistate Tax Commission. In practice, this means these states generally follow the same taxation procedures as member states, but reserve sovereign rights to craft their own procedures.

Associate members. Participate in Multistate Tax Commission meetings, programs, and projects, and consult and cooperate with the commission and member states. These states also tend to follow the same practices as member states without having adopted the compact.

Nonmembers. Do not participate in the compact.

Additional notes. Participating states are not required to adopt the entire compact and are free to adopt parts of it. However, states that do not adopt the compact in its entirety are not allowed to vote on the Multistate Tax Commission. Only member states are allowed to vote, and each member state has one voting representative on the commission.

Then vs. Now
Before UDITPA, states used a variety of methods to apportion income. In the 1960s, threat of federal intervention made uniformity a priority, and in furtherance of that goal, many states adopted UDITPA’s evenly-weighted, three-factor formula and joined the compact.

Today, uniformity is no longer a prime objective, as states struggle to incentivize in-state property and payroll while maintaining sufficient tax revenue in a changing economy. Many states, including compact member states, have adopted an apportionment formula that sources income based primarily on the location of a taxpayer’s sales rather than where the company owns property or employs its workforce.

Like California, many of these states did not act to formally withdraw from the compact before adopting these new apportionment formulas. If the US Supreme Court were to hold, as the taxpayers in Gillette advocate, that the compact is binding and cannot be unilaterally amended or overruled by state law, states could face billions of dollars in refund claims. This potential fiscal impact has prompted a number of states to formally withdraw from the compact in recent years. Further, a US Supreme Court ruling on the compact could prompt renewed interest in federal regulation of multistate taxation – and with it a new wave of state-led uniformity efforts.

Tax professionals must stay up-to-date, not only with the latest legislative changes affecting apportionment for future tax years, but also how cases like Gillette impact the available apportionment methods for prior tax years.


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