University of Southern California Dissertations and Theses

State Taxation Of Interstate Corporate Income

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State Taxation Of Interstate Corporate Income

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Content This dissertation has b een
microfilmed exactly as received 6 8 - 5 8 8 2
TRAINER, P a tricia D illon , 1937-
STATE TAXATION OF INTERSTATE CORPORATE
INCOME.
U n iversity o f Southern C alifornia, P h .D ., 1967
E con om ics, finance
University Microfilms, Inc., Ann Arbor, M ichigan
STATE TAXATION OP INTERSTATE CORPORATE INCOME
by
Patricia Dillon Trainer
A Dissertation Presented to the
FACULTY OF THE GRADUATE SCHOOL
UNIVERSITY OF SOUTHERN CALIFORNIA
In Partial Fulfillment of the
Requirements for the Degree
DOCTOR OF PHILOSOPHY
Economics
August 1967
UNIVERSITY O F S O U T H E R N CALIFORNIA
T H E GRADUATE SC H O O L
U N IV ER SITY PARK
LOS A N G E L E S, C A L IF O R N IA 9 0 0 0 7
This dissertation, written by
..........^ATRICIA..DILLQH.TRAIMR........
under the direction of h .& T S L —Dissertation Com
mittee, and approved by all its members, has
been presented to and accepted by the Graduate
School, in partial fulfillment of requirements
for the degree of
D O C T O R OF P H I L O S O P H Y
...
D ate S ep t emb e r 2 , 19 6 7 ....................
D ISSE R T A T IO N C O M M IT T E E
Chairman
TABLE OF CONTENTS
LIST OF
Chapter
I.
II.
III.
IV.
Page
TABLES.................................... iv
INTRODUCTION ............................ 1
The Problem
Objectives
Scope
Organization
Sources
A HISTORY OF THE PROBLEM: LEGAL AND
ECONOMIC ASPECTS ...................... 11
Limitations on States1 Powers of
Taxation
A SURVEY OF INTERSTATE CORPORATIONS AND
STATE LAWS............................ 44
Interstate Companies
State Regulations
THE TWO CURRENT PROPOSALS: THE INTER
STATE TAXATION ACT AND THE MULTISTATE
TAX COMPACT.......................... 87
The Present Proposal: H. R. 2158
The Multistate Compact
H. R. 2158 and the Multistate Tax
Compact Compared: The Sales
Factor Controversy
ii
Chapter Page
V. AN ECONOMIC APPROACH TO CORPORATE
INCOME TAXATION AT THE STATE
LEVEL................................129
VI. THE FUTURE OF STATE CORPORATE INCOME
TAX UNIFORMITY......................158
The Question of Congressional Action
The Debate Over the Interstate
Taxation Act
The Implementation of Uniformity
VII. SUMMARY AND CONCLUSIONS................... 178
Summary
Conclusions
APPENDIX....................................... 194
BIBLIOGRAPHY................................... 233
iii
LIST OF TABLES
Table Page
1. Revenue Significance of Income-Dividing
^Corporations.......................... 49
2. Nexus Standards for State Income Taxes
Imposed on Foreign Corporations .... 53
3. Division of Income for Tax Purposes* 1966 . 65
4. Apportionment Formulae in Use, 1929* 1948.,
I9 6 0, 1 9 6 6 ............................ 75
5. State Corporate Income Tax Rates for
Selected Years 1948-1966 .............. 78
6. Revenue from State Corporate Income
Taxation Selected Years 1927-1965 (in
millions of dollars) .................. 85
iv
CHAPTER I
INTRODUCTION
There Is virtually unanimous agreement among all
those involved with taxation by state governments of
businesses operating across state lines that reform is in
order. The unanimity ends there. In a tax system which
relies upon voluntary compliance and which is noted for a
high degree of efficiency and equity, interstate corporate
income taxation is Incredibly disorderly.
Thirty-nine states (including the District of
Columbia) levy corporate net income taxes. Each of these
taxing districts has devised regulations governing out-of-
state corporations which do business within the state's
boundaries. There is no universally accepted method of
assessing income tax liabilities for these multistate
firms. Indeed, no two states use exactly the same plan.
As the volume of commerce has expanded within the United
States, so have the problems resulting from the diversity
in rules concerning taxation of interstate companies. As
1
states' revenue needs grow at a phenomenal rate, the
problems take on added importance.
The Problem
The lack of uniformity in tax regulations among
the states is a significant problems it interferes with
the free flow of commerce and therefore hinders an
economic allocation of resources. The extent to which this
happens may not be great, but there is little doubt that
manipulation of business practices for tax purposes occurs.
Resources are wasted also through the use of lawyers and
tax accountants hired by firms to find ways to take
advantage of present differences in statutes. Just
keeping apprised of the law may be expensive, especially
for small companies. The necessity of knowing the
requirements of and complying with more than one tax
system, as well as the expense of maintaining the necessary
records, can give rise to excessive costs of compliance.
The situation is not much better for state tax officials.
They face expanding responsibilities on the one hand, and
insufficient funds, staff, and equipment on the other.
The costs of auditing and enforcing the tax liabilities of
all out-of-state corporations is prohibitive.
The collection problem is aggravated by poor
compliance, a good deal of which can be traced to
uncertainty of liability. Noncompliance is more nearly
the rule than the. exception. When costs of compliance
are large relative to the tax bill itself, the taxpayer
is tempted to hope for being overlooked by the tax
collector. However, the tax collector is not required,
to Justify the amount of tax assessed prior to its errtry
on his books. The system allows arbitrary assessments,
which can be upset only by legal action. The burdon of
proof is on the taxpayer to show that the assessment was
wrong, or that the method used to divide income reaches
an unreasonable result. In only one case has the
Supreme Court reversed a state court decision against a
taxpayer who had challenged the state’s apportionment of
net income.'*"
Since some states do not levy an income tax,
many corporations pay state taxes on less than their
total income. Nonuniformity creates the possibility of
a company being required to pay taxes on more than 1 0 0$
of net income. Duplicative taxation can occur when a.
firm is taxed by several states whose methods for
dividing income are not the same, and more than one state
claims Jurisdiction over the same portion of income.
Nonunifmrmity can lead to undertaxation too, in which case
intrastate firms are under some competitive disadvantage.
^ansRRees’ Sons, Inc., v. North Carolina ex rel.
Maxwell, 283 U.S. 1 2 3, 135 (1931).
4
Uniformity is -worthwhile for several additional
reasons. It would increase the possibilities for coop
eration among the states in the collection of taxes,
which in turn would alleviate the compliance problem.
Lastly^ uniformity in tax regulations would tend to
decrease expenditures for litigation of disputes over the
legality and meaning of division of income methods.
Suggestions for more uniform state tax regula
tions with respect to jurisdictional limits, definition
of the tax base, and division of income of interstate
businesses have been numerous. None have been implemented
to any significant degree. The resultant problems have
become serious enough, however, to have produced decisive
action. At present, two proposals, each with widespread
support, are pending. One is now before Congress, the
other is backed by the states. A major step will be taken
soon.
Objectives
This study will first undertake to demonstrate
the need for uniformity in state corporation income tax
regulations. This requires presentation of the
historical, legal, and economic background of present
practices. A survey of states' regulations--a picture of
the nonuniformity itself--helps to point up the dimensions
of the problem.
5
The two major proposed solutions to the problem,,
one from Congress and one from the states, are the
primary concern. They are presented, with their pro
visions explained, so that they can be compared and
subsequently evaluated. Implementation of uniformity is
the goal, and the objective is to determine how best to
accomplish this within the framework of the existing
system. An evaluation of tax programs for the purpose of
analyzing anticipated effects would not be complete
without consideration of the theoretical foundations of
the tax involved. Exploration of certain principles of
taxation will help set the perspective for viewing the
immediate problems of state corporation taxes. Valid
judgments require some consideration of the incidence of
the tax— who bears the monetary burden— and the justifi
cation for the tax. This provides a satisfactory basis
for proceeding to ideas about how the tax should be
levied; specifically, the rules for state corporate
income taxation and how they can be implemented.
This is the ultimate objective of the study: to
determine some recommended set of uniform regulations for
state taxation of interstate corporations, and to suggest
a method of implementing them. Such conclusions require
a look at the history of the problem of nonuniformity; the
extent of the present diversity; the theory of the tax
practices involved; the scope of proposed solutions; and a
6
good deal of controversy.
Scope
Only the corporate net income tax will be
considered in this study. This limitation reflects both
a major part of the development of interstate tax
problems* and considerations of effective manageability
of subject matter. Capital stock* gross receipts* sales
and use taxes are all ignored.
The second limitation pertains to the type of
business to be included. The study is limited to net
income taxes on corporations engaged in the sale of goods
across state lines--manufacturers, wholesalers* and
retailers. Businesses of these types account for a
major part of private economic activity in the United
States. Transportation companies* the communications
industry, public utilities* insurance companies, and
financial institutions are likely to have special
problems and are therefore excluded.
The analysis is restricted to corporations. There
are several reasons for this. First* most states which
levy corporate income taxes do not impose similar taxes
on unincorporated businesses as such. The incomes of the
latter are commonly taxed to the individual owners of the
companies* under the personal income tax. Even though
provision is usually made (as is the case for corporations)
for dividing such business income among states where the
business operates, use of personal income tax data would
greatly complicate a discussion of tax impacts and
revenue effects. The limitation to corporations results
in the inclusion of most manufacturing activity and a
substantial portion of all mercantile activity. Although
the number of unincorporated businesses is larger,
corporations are of far greater importance in terms of
total income earned. A great many of the unincorporated
businesses are small retailers, unlikely to be selling
access state lines.
It is not the intention of this study to present
an ideal system state taxation of corporations. It
is, rather, to work within the bounds of what is at
present possible to achieve. Theoretical considerations
must be balanced against political practicalities.
Concern will be confined to what can be accomplished now,
and how best to do so.
Organization
Both the problems and the arguments surrounding
their solutions are results of what has gone before.
Only in the recent past have decisive steps been taken
gState Taxation of Interstate Commerce, H. R. 1480,
Report of the Special Subcommittee on Sltate taxation of
Interstate Commerce of the Committee of the Judiciary,
House of Representatives, 88th Congress, 2nd Session,
June 15, 1964, pp. 16-17.
toward uniformity. Chapter II traces the genesis of the
controversy, including the sources of limitations upon
states’ taxing powers. Relevant methods and procedures
of state taxation of corporate income are explained.
These major fields of conflict are described— limits on
jurisdiction to tax and methods of dividing income among
the states— and some of the battle lines drawn.
Chapter III presents the significant characteris
tics of the interstate firm and of the statutes relative
to interstate taxation. The amazing diversity in state
tax practices is surveyed. The first Congressional
efforts at uniformity through legislation are outlined in
Chapter IV. Objections were so great that the initial
bill was replaced by another, which is the one now
pending before Congress. The provisions are explained,
followed by the same approach to the multi-state compact.
This compact is the states1 answer to proposals of
federal legislation. The major point of conflict in
these two plans is over the inclusion of a sales factor
(whether sales should be one of the bases for apportion
ing part of a company’s income to a state for tax
purposes). The latter part of Chapter IV is devoted to
presenting both sides of the argument.
Behind every controversial opinion there is a
theory; evaluation of the opinion should include evaluation
of the theory. In Chapter V corporate net income
taxation is examined from this angle. An analysis of the
burden of the tax provides a basis for evaluating it in
terms of its economic effects and its degree of equity.
It Is then possible to proceed to an analysis of the
corporate income tax at the state level, and of the
primary method employed to divide income among the states
for tax purposes. With the thought that broader reform
measures will eventually come about, the chapter is
concluded with a brief look at some alternate multilevel
fiscal arrangements. The emphasis is on improved
federal-state fiscal coordination.
Chapter VI reviews the justifications for and
arguments against federal and state solutions respectively
and finally evaluates the particular proposals now
pending. The last chapter contains a summary of the
studyi then, on the weight of theoretical analysis and
practical considerations, recommendations are made
concerning uniform tax regulations and their implementa
tion. Appendices contain the sections relative to net
income taxes of documents important to this study; the
Uniform Division of Income for Tax Purposes Act, Public
taw 86-272, House Report 2156, and the Multistate Tax
Compact.
Sources
In 1 9 6 1, the Special Subcommittee on State
10
Taxation of Interstate Commerce (Committee on the
Judiciary,, House of Representatives) undertook a study
spanning more than four years, the published results of
which brought together the greatest single body of
information on the subject ever c o l l e c t e d .^ Heavy
reliance has been placed on those volumes and the related
hearings. Other government publications, primarily those
of the Bureau of the Census, have provided data.
Most reference works in this field take a
business, legal, or accounting approach to taxes] these
have been balanced by public finance texts equally
concerned with the theory and principles of taxation.
Relatively few authors have devoted books to this subject
exclusively, but several excellent ones have appeared
within the last decade.
Legal publications have been used extensively,
especially journals and law review articles. The pro
ceedings and publications of various associations have
been invaluable for presenting the views of the major
groups concerned with interstate taxation. Finance
publications and tax services yielded very current data.
Economics, business, and tax journals were additional
sources of material.
3state Taxation of Interstate Commerce, op. cit.
CHAPTER II
A HISTORY OP THE PROBLEM: LEGAL AND ECONOMIC ASPECTS
Before making an assessment of state taxation of
corporate income or an evaluation of suggested improve
ments , it is necessary to know what lies behind the
current situation. All restrictions upon an individual
state's power to tax come from its own statutes and from
three other sources which apply to all states: the
Constitution, the judiciary, and the Congress. This
chapter explains the role each has played up to the
present.
The remainder of the chapter is given over to a
description of the significant elements of nonuniformity
in the state system of taxing corporate income: the
division of income among the states for tax purposes, the
question of what is sufficient to allow a state to assert
jurisdiction, and the definition of the tax base.
11
12
Limitations on States1 Powers of Taxation
Constitutional
The fundamental limitations upon the power of the
states to levy taxes on interstate business activity are
found in the United States Constitution. The commerce
clause (Article L, Section 8) states that Congress shall
have the power "to regulate commerce with foreign Nations,
and among the several States, and with Indian Tribes."
This assures free trade in the national market, although
taxation is not mentioned explicitly. The commerce clause
is unclear in its intent to disallow state activities
incompatible with the principles of free trade; prohibi
tion of state taxation of interstate commerce itself has
developed from judicial implication.
The due process clause (Amendment 14, Section 1)
is a general restriction on state powers. It has been
used to determine whether a tagcpayer's person or
activities are sufficiently related to the state to
2
justify taxation.
Neither of these clauses provides any readily
1
Charles E. Ratliff, Jr., Interstate Apportionment
of Business Income for State Income Tax Purposes, (Chapel
Hill; The University-of North Carolina Press), 1 9 6 2, p. 9.
p
John Wesley Cook, "State Net Income Taxation of
Interstate Commerce," Taxes, XLII, No. 8 (August, 1964),
p. 515.
13
determinable limitations upon state activity. So far
the outlines have been drawn, piecemeal, largely by
Judicial decisions and only supplementarily by
legislative action. The courts have allowed fairly
3
apportioned net income taxes on income derived from
purely interstate commerce. Taxes levied on the
privilege of carrying on interstate business, with that
privilege measured by net income, are unconstitutional.^
The economic effect of the two types of taxes is
precisely the same, and the differentiation is no longer
of great importance, since any tax measured by net income
is now generally regarded as an income tax.^
These broad Constitutional limitations apply to
Jurisdictional considerations only. Since state taxation
is not mentioned specifically, matters of definition of
taxable incomes the apportionment of such income go
untouched.
^Allocation is the process of determining that an
identified block of income arose in a particular place
and is attributable solely to there; it is the direct
assignment of specific types of income to a particular
location (e.g., rents to the situs of the property).
Apportionment is the determination that a computed
percentage of total income is attributable to a particular
place, with division of income based on a variety of
factors (e.g., property and payroll).
4
Cook, o£. cit., jp. 517*
^u.S., Congress, Multistate Tax Compact, Article
II, paragraph 3, and Interstate Taxation Act, 90th Cong.,
1st Sess., 1967.9 H.R. 215B, p. 9 ■ The Appendix contains
the texts of both.
14
Judicial
Until 1959, the only federal law limiting state
taxation of interstate commercial activity was decisional
law. The only guidelines, heyond individual states' laws,
came from the judiciary. The dominant view of the
Supreme Court has been that its function under the
commerce clause is one of striking a balance between the
interest in maintaining a common market and the interest
in preserving a Federal system.^ The due process clause
has been used primarily as a basis for setting the
jurisdictional limit of state taxing power.
The court has handed down some 300 decisions on
the problem of interstate taxation by states; the result
of so much effort has been characterized as a judicial
quagmire.^ No organized set of rules has emerged that
might have given some certainty to this area of the law,
since each court decision was for the purpose of
resolving a particular dispute. The consideration has
been of assuring fairness to the corporation in question,
fT
See Southern Pacific Co. v. Arizona ex rel.
Sullivan, 325 U.S. 7bl, 7b&-b9 (1945). Cited in State
Taxation of Interstate Commerce, H.R. 1480, Report of the
Special Subcommittee on State Taxation of Interstate Com
merce of the Committee on the Judiciary, House of
Representatives, 88th Cong., 2nd Sess., June 15, 1964,
p. 10. Hereafter referred to as H.R. 1480.
7
John Michael Webb, "State Taxation of Interstate
Commerce: The Current Status," Southwestern Law Journal,
XIX (March, 1 9 6 5), p. 170.
not of deciding whether or not* for example* an appor
tionment formula might lead to multiple taxation. Only-
infrequent ly has the opportunity arisen to proclaim a
general principle that could serve as a guide in some
related situation. Even these few principles are suspect*
since there is no assurance that the Court as constituted
at any given time will agree with the membership at an
earlier time. And decisions are very seldom unanimous.
Over a period of time* a shift in membership may turn
the minority dissenters into the majority. Some basic
national economic policy can conceivably be reversed by
the shift of one member* in a case where the Court is
O
split at five to four.
The Court is not the proper avenue for construc
tion of such policy. Its decisions must be narrow; it
cannot resolve problems growing out of the fact that
multiple taxation can affect the flow of capital into
multistate businesses and therefore distort business
decisions. The Court's inadequacy is entirely institu
tional. It deals in absolutes* and in this area an
absolute decision in either direction is likely to be
unsatisfactory. A decision to uphold a tax does not mean
that serious problems do not confront interstate commerce.
O
Walter H. Beaman* Paying Taxes to Other States, ,
State and Local Taxation of Non-Resident Businesses
(New York: The Ronald Press Company* 1 9 6 3)* Ch. 2* p. 2.
16
It means only that the Court considers striking down the
tax--the only method available to it for alleviating
those problems--to be of greater gravity than the
problems themselves. Even in this limited function,
the court is substantially handicapped by its inability
to explore fully the nature, extent, and impact of the
g
burdens c reated.
Although interstate tax: litigation has a long
history, a series of cases confronting the Supreme
Court in 1959 first brought widespread and concentrated
attention to bear on the particular problem of jurisdic
tion, i.e., what connection to the state constitutes
sufficient nexus to allow taxation. 10 Of these the
leading case was Northwestern State Portland Cement Co.
v. Minnesota, the opinion for which was rendered also
for Williams v. Stockham Valves & Fittings, Inc. In the
Northwestern case, the company rented an office in
Minnesota, from which it solicited orders which were
accepted and filled in Iowa. The Stockham firm rented
9H.R. l480, p. 11.
10Northwestern States Portland Cement Co. v.
Minnesota; Williams v. Stockham Valves & Sittings, Inc.,
358 U.S. 450 (1959); Brown-Forman Distillers Corp. v.
Collector of Revenue, 359 U»S. 28 (1959)7 dismissing
appeal and denying cert, in 23^ LA 651* 101 So. 2nd TO
(1950)j ET & WNC Transportation Co. v. Currie, 359 U.S. 28
(1959;* affirming per curiam 2^6 N.C. 5 6 0, 104 S.E. 2nd
403 (195^); International ISEoe Co. v. Fontenot, 359 U.S.
984 11959)* denying cert, in 23b La. 279* 107 So. 2d
(195o). Cited in H.R. 1480* p. 7-
17
an office in Georgia which salesmen used part-time. The
Supreme Court upheld the taxes imposed by Minnesota and
Georgia respectively. 1 1 This decision established the
constitutionality of a state tax; on income of foreign
corporations derived solely from interstate activities,
if the tax is non-discriminatory and properly apportioned.
This broadened the states' power to tax, but gave no
definition of what constitutes sufficient nexus. Tax
jurisdiction claimed by states ranged from a "substantial
place of business" or "permanent establishment" to the
mere existence of a market, the latter on the grounds
that the state benefits both the buyer and the seller.^
The decision did not attempt to cover the problems
stemming from diverse definitions of taxable income or
from different apportionment techniques. Apportionment
was left to individual states, with recourse to the courts
in ease of disagreements.
Three main themes emerged from the Northwestern-
-*"kjTohn Dane, Jr., "A New Look at State Taxation of
Income from Interstate Commerce," American Bar Association
Journal, LII (July, 1 9 6 6), p. 6 5 1.
12"State Taxation of Corporate Income Derived from
Interstate Commerce!. Public Law 86-272 and its Alter
natives, " Duke Law Journal, (1964), p. 5Q0 .
13john H. Wilkie, "Interstate Apportionment of
Business Income," Taxes, XXXIX, No. 4 (April, 1 9 6 1), p.
354.
18
Stockham decision: ^
1) interstate commerce receives benefits from
states wherein activities are carried on, and therefore
should bear its share of the state tax burden;
2) state taxes on net income should not
discriminate against interstate commerce in favor of
local business;
3) taxes must not be levied on the privilege of
engaging in interstate commerce.
The business community reacted strenuously and
nearly immediately, objecting that the decision was not
an adequate guide to tax liability. It was feared that
states would be tempted to push their jurisdictional
claims to the limit, and what that limit might be was by
no means clear to anyone. Companies doing small amounts
of business in several states were particularly concerned
about increases in both taxes and the number of returns
to be filed. The furor was so great that Congress acted
with something approaching record speed. Just after six
15
months when Northwestern, Public Law 86-272 was passed,
designed as a temporary measure to protect small firms
from anticipated increases in taxes and to givercertainty
■k^Paul J. Hartman, "State Taxation of Corporate
Income from a Multistate Business," Vanderbilt Law
Review, (December, 1959), P- 26.
^Public Law 86-272, 73 Stat. 555 (1959), as
amended, 15 U.S.C. 3B1-.84 (Supp. II. 1 9 6 1).
to the definition of nexus.
19
Congressional
The passage of Public Law 86-272 marked the first
time in history that Congress exercised its power to
regulate commerce between the states in the area of
state taxation of interstate business.1* ^ The law was
intended only as a stopgap, and provided for studies by
the Committee on the Judiciary of the House of
Representatives and the Committee on Finance of the
1 f t
Senate. The other major provision states that no
state or political subdivision thereof may tax the net
income of foreign individuals or corporations in inter
state commerce if the only activities in the state are
either or all of the following:
1) solicitation of orders sent outside the state
for approval and shipment]
2) solicitation of orders in the name of or for
the benefit of an in-state prospective customer of the
non-resident corporation]
3) sales representation by nonemployee agents
who represent more than one principal and who hold
16 0
'Duke Law Journal, op. cit., p. 5ol*
17
Jerome R. Hellerstein, "An Academician's View of
State Taxation of Interstate Commerce," Tax Law Review,
XVI (1961), p. 1 5 9.
■^Cook, op. cit., p. 5 2 6.
20
themselves out as agents in the regular course of their
iq
business. ^
Opposition to P.L. 86-272 stems from two sorts
of bases. One is the point of view that the law causes
more problems than it solves. Some objectionable points
most frequently mentioned are the following:
1) Most areas of business transactions are
untouched. There is no coverage for sales of intangibles
and of services.
2) Tangible personal property is not defined,
and there are diverse uses of the term in various state
laws.
3) There are no guides provided as to what
constitutes "solicitation," "delivery," or "sales."
Since the scope of such activities is not clear, it is
impossible to determine what related functions might
sustain a tax (e.g., might an extensive advertising
campaign be a part of solicitation; or, might sales and
delivery include installation, supervision, repairs,
20
servicing?"
4) Activities of "independent contractors" are
deliberately and in detail precluded from being imputed
to persons on whose behalf sales are made or orders for
^The Appendix contains the text of P.L. 86-272.
^°Robert L. Roland, "Public Law 86-272: Regulation
or Raid?" Virginia Law Review, XLVI No. 6 (i9 6 0), p. 1180.
21
P I
sales are solicited. The definition of independent
contractor and the scope of permissible utilization of
such are unclear.
The only answer to criticisms like these is
that the statute was written as a limitation on state
power, and does not attempt to define affirmatively the
activities which create liability. In areas not
covered by the law, the issue of the states1 power to
tax remains a question for the courts. The policy behind
the statute was maintenance of the status quo existing
prior to the court decisions of 1 9 5 9 (primarily,
Northwestern-Stockham). P.L. 86-272 did not materially
contract the taxing Jurisdiction of the states, but was
meant to prevent an increase in the number of returns
businesses had to file. It was enacted as stopgap
legislation to forestall possible expansion of states'
taxing Jurisdiction; its purpose was not to change the
pre-existing rules, but only to resolve some Jurisdic
tional issues which had not been finally resolved through
pp
the litigation process. The bill was not designed as
an avenue toward uniformity in definition or apportion
ment of income.
21Richard L. Hirshberg and Alan M. Nedry, "A
Federal Concept of Doing Business," Virginia Law Review,
XLVI No. 6 (October, I960), p. 1242. Cites 15 U.S.C.
sections 381 (e)-(d) (Supp. I, 1959)*
22h.r. i48o, p. 4 3 8.
The second major type of criticism of P.L. 86-272
questions the statute's constitutionality. Proponents
of this view regard the law as an "unlawful raid on the
inherent and reserved, albeit rapidly diminishing rights
of the states." The basic argument is that since
commerce itself is completed before the tax in question
is imposed, it is not commerce that is being regulated,
but taxation. And Congress may not deprive a state of
a power necessary for its survival— i.e., the power to
Pit
tax. Congress has no right to deny or limit the rights
of states to levy nondiscriminatory net income taxes. On
such grounds has this Act been called an illegal,
inequitable, illogical assumprtion of federal power.2- *
This argument has, in effect, been countered by
the fact that the constitutionality of P.L. 86-272 has
been upheld by the Supreme Courts of Oregon, Louisiana
and Missouri.2^
^Roland, oj>. cit., p. 1173*
2^Xloyd W. Herrold, "Current Developments in State
Taxation of Interstate Commerce," Marquette Law Review,
XLVII No. 4 (Spring, 1964), p. 445.
25
Roland, oj). cit., p. 1 1 8 9.
international Shoe Company v. Cocreham, 246 La.
244, 164 So. 2d 314 (1984), cert, denied, sab, nom.,
Mouten v. International Shoe Company, 379 U.S. 902 (1 9 6 5);
Cib'a 'Pharmaceutical Products v. State Tax Commission, 382
S'.W. 2d 645 (Mo. 1964). Smith, Kline and French Labora-
tories v. State Tax Commission, CCH State Tax Cas. Rep.
250-116 (Ore. April, 1964V, rev»d., 403 P. 2d 375 (Ore.
1 9 6 5). Cited in "An Analysis of the Net Income
The most Important result of the passage of this
law was the Congressional study of state taxation of
interstate commerce for which it provided. The nature,
content and conclusions of that study will he covered
at length in a later chapter. To date, P.L. 86-272 is
still the first and only federal legislation concerning
taxation of multistate businesses by the states.
The Significant Elements of Nonuniformity
The problematical areas of interstate taxation
by the states are jurisdiction to tax, definition of
income for tax purposes, and apportionment of that
income. The deleterious economic effects of the lack of
uniformity in state regulations covering these areas have
been recognized for more than 45 years. A National Tax
Association committee first presented a model plan for
state and local taxation in 1 9 1 9; many more followed,
but no real progress toward uniformity came from them.^
Division of Income
Of the many methods devised for dividing income
of interstate corporations among states, the most
frequently used are discussed here.
Formula Apportionment. The factors in an
Tax Provisions of the Interstate Taxation Act (H.R. 11798)
Vanderbilt Law Review, XIX (March, 1 9 6 6), p. 526.
2^Ratliff, op. cit., p. 1 7.
apportionment formula represent an attempt to relate the
taxpayer's presence within the state to his presence
elsewhere. Accordingly, each factor is expressed as a
fraction, with the numerator representing dollar value
within the state and the denominator dollar value every
where. The ratio to be applied to the apportionable
income is normally obtained by averaging the factors in
the following manner, here assuming the use of a three-
factor formula:
In-state property In-state payroll In-state sales
Total property Total payroll + Total dales
3
Assume that a corporation attributes to the state
$400,000 in property, $30,000 in payroll, and $7 5 0 ,0 0 0
in sales. Its total property everywhere is valued at
$8 0 0,000] total payroll, $9 0,000] total sales, $1,5 0 0,000.
The apportionment ratio would be computed as follows:
400,000 30^000 . 750j000
bOOjOQO 90,0UU~ + lj^OOjQOO' = Apportionment
^ ratio
or
1/2 + 1/2 + 1/2 = 4/9 (Apportionment ratio)
3
If the company's net income were $50,000 and the tax
rate were 5$* the tax liability would be computed as
follows:
25
4/9 x $5 0 ,0 0 0 = $2 2,2 2 2 .2 2 (taxable income)
$2 2,2 2 2 .2 2 x .0 5 = $1 1 1 1 .1 1 (tax)
In a state with a two-factor formula, each
factor is applied to one-half of the apportionable net
income; in such a state, therefore, each of the factors
has greater significance in the apportionment process
than would an identical factor in a three-factor scale.
Formula Apportionment Using Three Factors: The
28
Uniform Division of Income for Tax Purposes Act.
Definitions of apportionable income usually cover all
income earned from the sale of goods in the regular
course of business, but state regulations vary consid
erably with respect to what classes of income are
included. Of all the uniform plans which have been
proposed over the years, the Uniform Division of Income
for Tax Purposes Act (USITPA) has been the most popular
among the states. It is also important because it has
been the basis for state-supported proposals ever since
its appearance in 1957* It employs the typical three-
factor formula.
The National Conference of Commissioners on
Uniform State Laws has been functioning since 1 8 9 2; its
members are appointed by state governors, and its
28rhe Appendix contains the text of UDITPA.
26
purpose is to formulate uniform legislation for adoption
by the states. It does not confine its attention to
tax matters. ^ In 1957 it drafted UDITPA and recommended
enactment in all states. The Act had the official
approval of the Council of State Governments and the
American Bar Association.^ 0
UDITPA is specific with respect to apportionment
and jurisdiction by providing for a three-factor formula
for apportioning income attributable to a given state*
the factors incorporated are payroll* property* and
sales. Sales of tangible personal property are consid
ered in the state if ( 1) property is delivered or
shipped to purchasers in the state (other than the U.S.
government); or ( 2) property is shipped from an office*
store* warehouse* factory* or other place of storage
within the state and the purchaser is the U.S. government
or the taxpayer isn't taxable in the state of the
i
purchaser.31 Thus sales are determined for tax purposes
on a destination basis* except in the limited situations
where the federal government is the purchaser or where
the purchaser is located in a state where the taxpayer's
business activities are not subject to an income tax.
29pred L. Cox* "The NCCUSL Uniform Apportionment
Formula*” Taxes* XLII No. 8 (August* 1964)* p. 530.
3°Ratliff* o£. cit.* p. 21.
^Section 16 of the Act.
27
In such limited cases, the hhsis for allocation is that
of origin. Still the taxpayer's net income might, in
part, escape taxation, because of the way in which the
act uses the word "taxable." A taxpayer is considered
"taxable" in another state ( 1) if he is actually subject
to an income tax there, or (2) if that state has Juris
diction to subject him to an income tax, regardless of
32
whether or not it has done so. When sales are
allocated to a state that doesn't levy corporate income
tax, less than 1 0 0# of a company's net income would be
taxed under state income taxes.
Sales of intangible property are considered to
be in the state if ( 1) income-producing activity is
performed in the state; or ( 2) income productivity is
both in and out, and the greater proportion is in the
state than in any other, based on costs of performance.
If the provisions of the act don't fairly
represent the taxpayer's business activity in the state,
he may petition for, or the tax administrator may require,
one or more of the following: separate accounting,
exclusion of any one or more of the factors, inclusion of
one or more additional factors more representative, or
employment of any other method to effectuate equitable
32Section 3 of the Act.
28
allocation and apportionment of income. J
UDITPA covers both jurisdiction and division of
income (apportionment) problems, and would make regula
tions with respect to these two areas uniform. It is not
specific in its treatment of definition of the tax base,
leaving this up to the states. The major source of
controversy in connection with' UDITPA is the sales
factor in the apportionment formula, an extensive
discussion of which is contained in Chapter IV. Those
who favor use of a skies factor in the apportionment
formula (mainly state tax administrators) do so primarily
on the grounds that some recognition should be given the
state providing the market. That market gives realization
to income; there would be no income without the sale.3^
The other two factors used in the apportionment
formula, property and payroll, are included virtually
in the same form in the proposal currently supported by
the states. The property factor is a fraction, the
numerator of which is the average value of the taxpayer's
real and tangible personal property owned or rented and
used in the state during the tax period and the denomina
tor of which is the average value of all the taxpayer's
real and tangible personal property owned or rented and
33section 20 of the Act.
3^htfilkie, op. cit., p. 3 5 6.
29
used during the tax period.35 Property owned is valued
at original cost; rented property is valued at eight
times the net annual rental rate (rate paid "by taxpayer
less any annual sub-rentals received).3^ Although
there has been criticism of the practice of valuing
property at original cost* both the pending federal
legislation and the proposed state compact do so. The
use of book value might be more convenient, but it would
tend to distort the relative contributions of old and
new facilities.37
The payroll factor is a fraction, the numerator
of which is the total amount paid in the state during
the tax period by the taxpayer for compensation, and the
denominator of which is the total compensation paid
everywhere for the period.3^ Compensation is paid in
the state if the individual's service is performed
entirely within the state; or some is in and some out,
with the latter incidental to the former; or some is
performed within the state and the base of operations or
place from which the service is directed or controlled
is in the state. If the latter is in no state in which
35section 10 of the Act.
3^Section 11 of the Act.
37Ratliff, oj>. cit., p. 23.
38section IB of the Act.
30
some part of the service is performed, then the individ
ual's residence constitutes nexus for taxation.39
Criticism of the payroll factor in negligible, since the
taxpayer can usually use the same basic data for both the
payroll factor and for unemployment compensation tax
40
purposes. UDITPA has been adopted, in subfe&anee, by
16 states, but ■with various modifications.^
Apportionment Using a Two-Factor Formula. One
of the major differences between the states' proposals
concerning uniform regulations and the proposals contained
in pending federal legislation is the type of apportion
ment formula preferred. The federal act favors a two-
factor formula based on property and payroll, and not
including sales. Reasons and ramifications are covered
in Chapter IV. Basically, the argument for this point of
view centers on the contention that human effort and the
use of property produce income. The payroll and property
factors account for these, and their respective defini
tions are much the same in both the current proposals.
Selling and purchasing do not produce income except as
39section 14 of the Act.
^°Ratliff, loc. cit.
^Prentice-Hall, Inc., State and Local Tax Service,
pp. 1039-1040, dated September "2Tj"" 190^. The' states are
Alaska, Arkansas, California, District of Columbia, Idaho,
Indiana, Kansas, Kentucky, New Mexico, North Dakota,
Oklahoma, Oregon, South Carolina, Utah and Virginia; West
Virginia as of July 1, 1 9 6 7.
31
human effort and property are involved. A sales factor
is duplicative, giving undue importance to one type of
effort and resource use, according to advocates of the
JL l o
two-factor formula.
Separate Accounting. Separate accounting is a
method employed to determine what portion of a corpora
tion’s operating income (i.e., income growing out of the
general business of the taxpayer as contrasted to income
from dividends and the like) is taxable by a given state.
For this purpose, books are kept for each state in which
business is transacted, as if that state were a separate
43
business unit. The technique is used in lieu of the
other two predominant methods of dividing income, formula
apportionment and specific allocation (discussed below).
A small number of income tax states appear to
show some preference for separate accounting in their
statutes. Several prohibit it altogether; a very few
permit it only in special, carefully defined circumstances.
In 2/3 of the states there are broad provisions allowing
separate accounting where the prescribed method for
dividing income produces inequitable results, as determined
44
by the administrator. It is only rarely permitted. A
42c. Lowell Harriss, "Interstate Apportionment of
Business Income," American Economic Review, - XLIX_(<£une,
1959), P. 400.
^Beaman, oj>. cit., Ch. 3 p. 4.
44h.r. 1480, p. l6l.
32
more detailed picture of state tax regulations is
contained in the following chapter.
The reasons for the nonuse of separate accounting
are based upon both administrative and theoretical
problems. Proponents argue that it is more accurate than
the apportionment method.^ But its drawbacks are
numerous. Separate accounting breaks down when the
activities that constitute a nexus in a foreign state are
too meager to be accounted for separately3 and are there
fore* treated as a part of the larger business unit. A
major reason that separate accounting is not popular with
state tax administrators is that it often requires the
making of judgments and reasonable approximations by the
accountant who keeps corporation books. Tax administra-
46
tors are typically suspicious of this.
Separate accounting attributes all income to
centers of activity and assigns no income to geographical
areas where the taxpayer is not present3 or is present
only on a transient basis. Yet customers of the business
may be located in these areas. Efforts of traveling
salesmen are treated as being concentrated at their
47
headquarters. ' Another criticism is that separate
^ R atiiff3 o£. cit., p. 24.
^Beaman* loc. cit.
4 7Ibid. 3 Ch. 3 p. 5.
accounting usually increases administrative costs
through, for example, higher state auditing costs and
high costs of compliance. A corporation must keep sepa
rate records for each state in which any business
activity occurs, even though state boundaries may not be
relevant regional demarcations for his own business
purposes. In the case of a company making interstate
shipments of goods between its own business locations, the
use of separate accounting, requires that a hypothetical
selling price be established for each such transaction.
When one business location ships a product to another,
the transaction will normally be treated as a sale; the
hypothetical selling price will be included in the gross
receipts of the first business location and will become
part of the cost of goods sold for the second. The
setting of such prices leads to additional problems. All
this detracts from the validity of the separate accounting
technique. Another difficulty arises with the attributing
of overhead items (e.g., salaries for general executive
officers) among the various business locations of the
taxpayer.
Separate accounting is impractical and theoret
ically unsound because net income may be, at least
partially, a result of interdependence of business units
^8H.R. 1480, pp. 164-166.
34
in various states. Dividing income by this method
precludes measurement of many factors which contribute
to income, such as economies of scale, management
abilities, advantages accruing to volume purchasing, and
the attraction of capital by the offer of greater investor
security.^9 xt is almost universally true that state
tax administrators are extremely reluctant to permit the
use of separate accounting by businesses deemed
"unitary,"5® although these administrators may differ on
what sorts of firms are or are not unitary.
Specific Allocation. Specific (or direct)
allocation is another method of dividing income among
states; it is employed in varying degrees by most income
tax states in conjunction with formula apportionment.51
The technique is applied to certain classea of income
considered unapportionable, being often used to determine
what portion of income from intangibles and non-operating
income is taxable. Specific allocation is undertaken
before dealing with operating income, and before applying
49"Developments in the Law: Federal Limitations on
State Taxation of Interstate Business," Harvard Law
Review, LXXV No. 5 (March, 1 9 6 2), p. 1010.
5°in a unitary business, the business establishment
of the company are mutually dependent upon each other for
their success. The separate accounting method does not
reasonably reflect the income attributable to each
establishment.
51H.R. 1480, p. 216.
35
the apportionment f o r m u l a .52
Examples of non-operating incomes are rentals,
capital gains from real and tangible property, dividends
and interest from investment, royalties from patents and
copyrights, and income from personal services. Such
items are usually specifically allocated, meaning taxed
or excluded in their respective entireties by the taxing
state. 53 This method of attribution involves, more
directly than any other, an attempt to determine the
geographical source of certain types of income% indeed,
it may be defined as the assignment of particular items
of income to particular geographical locations.5^
Definitions of specific allocation are not uniform among
states. There is disagreement as to what kinds of income
are to be specifically allocated, and where a particular
type of income is to be attributed. The taxpayer must
become familiar with a very broad range of rules. The
diversity of these rules creates many opportunities for
overtaxation and undertaxation. Some items of income may
be allocated to each of several taxing states, btohers may
not be claimed by any state, .or some may be allocated by
some and subjected to apportionment by formula in others.
52cook, o£. cit., p. 5 2 0.
^ Harvard Law Review, loc. cit.
^Beaman, o]D. cit., Ch. 3 P- 5*
36 = ■
With respect to types of income subject to allocation and
to attribution rules, there are no regulations of
universal applicability, as will be seen in the next
chapter. Treatment of income is so diverse that one is
led to the conclusion that it is futile to search for the
single true source of any particular item of income earned
by a multistate taxpayer. ^
Equity Capital as a Basis for Apportionment.
It is possible to advance proposals for apportioning
income which are based on sound economic theory but
which are impracticable. An example of this is the
apportionment of income on the basis of the location of
equity capital. The idea might appeal to economists on
the theory that net income is attributable to such
capital, other factors receiving their marginal products.
Without evaluating that theory, it is apparent that there
is no basis for apportioning a firm's equity capital among
states except by using some method no less arbitrary than
those employed in the conventional formula.-^ Since the
current situation involves two specific, workable alter
natives, this analysis will be limited primarily to such
proposals. Most diversity of opinion in this field is
accounted for by practical, political considerations
55h .r. 1480, loc. cit.
^Harriss, op. cit., p. 401.
37
rather than by differences in basic theories, whether the
protagonists are accountants, administrators, economists,
Congressmen, lawyers, or businessmen. In conjunction with
evaluation of current proposals and recommendations for
future practices, some imaginative departures from
traditional ideas about state financing are discussed in
Chapter V.
Jurisdiction
The Uniform Division of Income for Tax Purposes
Act does not set out jurisdictional standards as such;
but the use of the three-factor formula indicates that
instate selling activity can make a corporation taxable
by that state. P. L. 86-272, on the other hand, pro
hibits taxation of the net income of corporations whose
only activities in a state are solicitation of orders
sent outside the state for approval and shipment. States-
are adamant in their objections to federal jurisdictional
restrictions. Their current proposal for uniformity, as
will be seen in Chapter IV, would allow for taxation on
the basis of sales activity. P. L. 86-272 appears to
limit the states to taxing corporations which have an
instate business location (permanent establishment).
Partially Quantitative Jurisdictional Rules. One
suggested remedy to jurisdictional problems would define
minimum nexus in terms of doing some specific dollar
38
57
amount of business within a state during the tax year.
Such a rule would most likely be used in conjunction with
an apportionment formula based on a qualitative rule
(e.g., permanent establishment). It would be provided
that a company would be taxable in a state either if it
had certain kinds of activities there or if it shipped a
stated volume of goods there. It might also be that the
existence of a certain amount of payroll or property in
a state would provide a basis for taxation even in the
absence of the kinds of activity covered by the qualita-
58
tive part of the regulation.
A minimum nexus standard of this sort would
exempt small interstate corporations from the corporate
income tax, as well as those operating in states where
their income was very small. ^9 This proposal has not been
embodied in either the federal^interstate taxation bill
or the multistate compact. Rather, as will be pinpointed
in Chapter IV, the federal bill excludes corporations with
average annual (taxable) earnings of more than one
^fjerome R- Hellerstein, "Allocation and Nexus in
State Taxation of Interstate Business," Tax Law Review,
XX (January, 1 9 6 5), p. 277.
58H.R. 1480, g. 5 0 8.
59jbjd., p. 513.
39
6o
million dollars from coverage by its provisions. The
multistate compact, on the other hand, makes some special
provisions for companies whose only activity within a
state is selling (no property owned or leased), and gross
volume of instate sales is not more than $100,000. But
this is not in any sense an exemption.
There are enough problems involved in the use of
minimal quantitative nexus to make its avoidance under
standable. For example, a porporation would have to keep
the same records to prove exemption that would be neces-
62
sary if it were subject to taxation. In addition, some
companies might experience significant changes from year
to year in the particular states in which they are
liable. Although the purpose of a partially quantitative
standard is to reduce the number of states in which
returns are required in any one year, some companies
might find that they incurred a tax liability in ammuch
larger number of states over a relatively short period of
years. 3 Improved voluntary compliance might be expected
because of greater certainty of tax liability under a
quantitative criterion; on the other hand, it would be
^ Interstate Taxation Act, Section 506 (a) (3). -
^ Multistate Tax Compact, Article III, paragraph 2.
u^Duke Law Journal, op. cit., p. 593-
63H.R. 1480, p. 512.
4o
more difficult to locate the taxpayer than is the case
using a qualitatively defined nexus. The primary
advantage of the partially quantitative rule is that it
can limit the scope of potential liability in a manner
correlated with the size of the company. Some larger
companies, however, would thereby have a wider spread of
potential liability in states where they would not be
taxable under the business location (permanent establish
ment or place of business) test.6^
Definition of Income
This chapter has.so far been concerned with the
circumstances in which a corporation becomes liable to
file an income tax return in a state, and the methods
prescribed by the state for the division of income. This
particular section is concerned with the tax base and the
rules for determining the taxpayer's total taxable income
without regard for how it is to be divided among the
states in which business is carried on. Jurisdictional
provisions and rules governing the division of income are
features of the state income tax system which are applic
able exclusively to interstate corporations. In contrast,
the state rules for the computation of taxable income
65
apply to all corporations, whether interstate or not.
6^Ibid., p. 510.
65ibid., p. 569.
4l
Consideration of state rules for defining income
inevitably results in comparison with the federal provi
sions, for several reasons: the federal tax is a common
reference point for all who file state income tax returns;
because rates are high, federal tax law requirements are
usually reflected in taxpayers' bookkeeping procedures;
and federal tax administrators have taken the lead in
developing comprehensive, sophisticated rules for
66
taxing. The federal income tax is so nearly universal
that it has come to dominate the whole field of income
taxation. But the taxpayer is frequently confronted with
the problem of computing his income tax one way for the
federal government and several other ways for states.
There are differences between the states and the federal
government and among the states on such matters as
allowance of deductions for taxes paid to the taxing state,
to other states, and to the federal government; treatment
of capital gains and losses; provisions governing carry
back and carryforward of net operating losses; rules
affecting depreciation schedules, to name a few.^7
While all the income tax states have definitions of
taxable income which differ in some respects from the
federal definition, there is in each-state some degree of
66Ibid., p. 255.
67Ibid., p. 105.
42
conformity with the federal base. The extent of this
conformity will be explored in the next chapter.
The economic significance of diversity in the
definition of tax base in different states has been
discussed in the introductory chapter. At least half
of the states have adopted within their tax bases defini
tions whose provisions have the effect of making tax
burdens depend on the location of corporate facilities
or activities. At the present low rates of state income
taxation, the significance of such provisions would not
seem to be great. However, the direction of their effect
appears to be to restrict or divert corporate activities
along state lines.^ This, along with the economic waste
that compliance problems bring about, is certainly a
detriment to the goal of efficient resource allocation.
The sources of limitations on states’ taxing
powers and the important elements of interstate corporate
taxation as implemented up to the present have been
described in this chapter. The same elements are relevant
to the proposed federal legislation and the multistate
tax compact. There have been other methods suggested that
fall outside the traditional framework— some based on
criticism of the corporate income tax as a justifiable
revenue source, and some based on different concepts of
68Ibid., p. 276.
43
intergovernmental relationships. Such ideas -will be
discussed further in later chapters in connection with
recommendations for implementing uniformity in interstate
corporate income tax practices.
CHAPTER III
A SURVEY OF INTERSTATE CORPORATIONS
AND STATE LAWS
the background of the problem of nonuniformity
in state tax regulations has been outlined, along with
the sources of limitations on state taxing powers and
how they have so far been exercised. The principal
methods used to tax the incomes of multistate corporations
were explained. This chapter is intended to convey first —
a picture of the companies being studied— manufacturing
and mercantile corporations operating across state lines--
and next a picture of the diversity in the application
of the tax practices that have already been defined.
The latter part of the discussion is organized around
the problematical areas of nonuniformity in state
corporate income tax regulations.
Interstate Companies
The single most comprehensive study of
44
interstate commerce to date is that of the Special
Subcommittee on State Taxation of Interstate Commerce. 1
The study* provided for in Public Law 86-272* was begun
p
in 1961 and completed in 1 9 6 5. The Subcommittee used
available published data and replies to its own
questionnaires as empirical bases for its work.3
Utilizing information formulated within that study* it is
possible to set out the salient features of corporations
engaged in interstate commerce.
At the very minimum there are 120*000 manufac
turing and mercantile corporations engaged in interstate
business mn the United States* and the number is probably
much larger.^- The interstate company is one whose
activities are such that more than one state might assert
tax liability. This does not include companies with an
essentially local market but which make occasional out-of-
1State Taxation of Interstate Commerce, H.R. l48o.
Report of the Special Subcommittee on State Taxation of
Interstate Commerce of the Committee on the Judiciary*
Houseeof Representatives* 88th Cong.* 2nd Sess* Vol. 1
& 2* Junr 15j 1964 (hereafter referred to as H. R. l48o)j
H. R. 565j 8 9th Cong.'*" Is¥"Sess""."* Vol. 3* June' 30* 1 9 6 5;
H. R. 952* 8 9th Cong.* 1st Sess.* Vol. 4* September 2*
1965.
2Public Law 86-272* 73 Stat. 555 (1959) Section
201* as amended* 15 U.S.C. 381-84 (Supp. II. 1 9 6 1). See
the Appendix for the text of P.L. o6-272.
3por information on sources and methods used, see
H. R. 1480, Chapters 2 and 3j &ncl Appendices A-P.
^H. R. 1480* p. 90.
46
state shipments, such as gift shops; or companies which
make no out-of-state selling efforts at all but regularly
supply some product to buyers in other states. Also
excluded are companies which are essentially local but are
incorporated in states other than those in which they
operate. Such companies may pay taxes in more than one
state, but not because of engaging in interstate
5
commerce.
A majority of the businesses which are interstate
appear to be companies with less than $1,000,000 of
annual sales, and about half have fewer than 20 employees.
Substantial proportions— about 4o$--have annual sales of
less than $500,000; and nearly a third employ fewer than
g
10 persons. These small companies are more often than
not unaffiliated with any other business. They are
independent enterprises, not subsidiaries of corporate
giants. In fact, the existence of an affiliation seems
to be least common among the very smallest.^
The overwhelming majority of interstate companies
have actual places of business in only one state. It is
exceptional for a company with less than $5,0 0 0 ,0 0 0 of
gross receipts to maintain a business location in more
than one state. Even among firms with gross receipts
5Ibid., p. 7 0.
^Ibid., Table 4-3, p. 74; and Table 4-1, p. 72.
7Ibid, 3 1 p. 75-
between $5,0 0 0 ,0 0 0 and $5 0,0 0 0,0 0 0, the majority have
places of business in three states or less. Only in the
larger corporations (as measured by sales) is a wide
spread of places of business characteristic; yet many of
8
these have a narrow spread. On the other hand, many
interstate firms distribute their products nationwide,
and most ship into several states. Especially among
manufacturers, even the smallest, the typical situation
is characterized by markets far removed from the produc
tion facility.9 Among the manufacturers studied by the
Subcommittee, about half had sales in 16 or more states
in which they had no place of business. More than one-
fifth had sales in 4l or more such states.1^ Mercantile
concerns have narrower sales dispersions, but many—
especially the small ones— have wide distribution patterns.
More than one-fifth had sales in 16 or more states where
they had no place of business; and almost one-tenth had
11
sales in 4l or more such states.
The spread of places of business and the spread
of sales are roughly representative of the two extreme
8Ibid., Table 4-5, p. 77; and Table 4-6, p. 78.
9Ibid., Table 4-7, p. 80.
1QIbid., Table 4-9, p. 82.
11Ibid., Table 4-8, p. 8l; and Table 4-10, p. 84.
positions with respect to the appropriate scope of tax
liability for the interstate company. There has been
much argument in favor of income tax liability only in
states where the corporation maintains a permanent place
of business. On the other hand, the internal logic of
some states’ taxes suggests^that a business should be
liable for income taxes in every state to which the
company ships products. Consideration of the patterns of
business activity outlined above points up the great
distance between these two positions.
Although no states maintain statistics showing
the amount of revenue coming from interstate corporations,
nine states were able to provide data to the Subcommittee
showing the amount of revenue coming from corporations
which divided their income on their tax returns. Most of
the nine were able to break this information down further
into mercantile and manufacturing corporation figures, as
demonstrated in Table 3-1. The figures may be expected
to understate the importance to these states of income
tax revenue from interstate corporations, because they
show only the extent to which reliance is placed on those
companies which had sufficient interstate activities that
they were not required to assign their entire incomes to
one state. The conclusion is still clear. For each of
the nine, more than half of all corporate income tax
revenue was from companies being taxed on less than their
TABLE 3-1
REVENUE SIGNIFICANCE OF INCOME-DIVIDING CORPORATIONS
Percentages of income tax
tions which
revenue derived from
divide their incomes
corpora-
Year
of
data
Manufacturing
& mercantile
corporations
All corpor
ations
California
1959
6 9 .4 55-8
Colorado
1959
n • 3* •
59.2
Idaho i960 6 9 .0
57.7
Minnesota
1959
n.a. 5 1 .2
New Jersey i960 n.a. 64.8
New York i9 60 6 6 .8 6 0 .0
North Carolina
1959 65.5
6 5 .8
Oregon i960 6 0 .6 5 2 .6
Tennessee
1959
81.4
76.9
All states with data 6 8 .1
58.9
n.a.: data not available
Source: State Revenue Questionnaire, Special
Subcommittee on State Taxation of Interstate Commerce,
Committee on the Judiciary, House of Representatives,
House Report No. 1480, State Taxation of Interstate
Commerce, 88th Congress, 2nd Session, June 15, 1964, p. 88.
50
entire incomes. Of the six states able to supply this
data by industrial classification, all reported that more
than 60 per cent of the combined revenue derived from
manufacturing and mercantile companies came from com
panies paying taxes to more than one state.
These nine states represent substantial diversity
in terms of the economic structures of the states. As
a group, they receive more than half of all state
12
corporation income tax revenues. In view of the sub
stantial similarity of the results for all these states,
there is a good possibility that they are quite represent
ative of income tax states generally. It may be that,:
among the remaining states, there are some which are
exceptions to the rule that interstate corporations are
the source of the largest part of corporation income tax
revenue. It is unlikely, however, that there are many
exceptions. In revenue terms, therefore, a study of
state income taxation of interstate companies is a study
of the core of the state corporate income tax system.
Most of the companies engaged in interstate
commerce do not pay taxes of any kind in more than one
state. The companies that do so are the small minority
of very large firms that provide the bulk of the revenue
derived from state corporate income taxation. The
1 2lbid., p. 8 9.
picture of the typical interstate firm that emerges,, then,
is one of a small business enterprise. Such companies
are usually not organized to deal with state tax problems
in a very sophisticated way. Except in the largest
companies, the development of information needed for
state tax purposes is a task not integrated into the
normal bookkeeping and accounting procedures of the firm.
This limits such a company's ability to deal with com
plexities; and it is this company that is predominant in
terms of numbers. On the other hand, the significant
companies in terms of revenue are the very large ones
capable of dealing with a complex array of regulations
and requirements.*^ Thus, while interstate companies as
a whole constitute a major revenue source, the group
comprises a large number of companies which are relatively
inconsequential in revenue terms, and only a small
number of which have major revenue significance. It is
in this context that state taxation of interstate commerce
must be considered.
State Regulations
Some knowledge of the tax systems of the states
is essential to an understanding of their collective impact
on interstate commerce. The descriptive comments that
follow are organized around the major problem areas of
3-3ibid., p. 91.
52
state taxation of interstate corporate income: jurisdic
tion to tax (what constitutes sufficient nexus); defini
tion of taxable income (what constitutes the tax base);
and methods of dividing income (what part of a company's
income "belongs" to a given state). A brief survey of
tax rates and another of revenue significance of state
corporate income taxes are included.
As is the case throughout this paper, Alaska,
Hawaii, and the District of Columbia are treated as
states, regardless of their respective political status
at any time.
Jurisdictional Provisions
With respect to jurisdictional rules determining
what makes a corporation's income taxable, state laws are
characteristically indefinite. The assertion of tax
liability by a state is often involved with the issue of
state power and the limits thereto. This matter was
discussed in the last chapter.
Table 3-2 demonstrates the great diversity among
states regarding corporate income tax liability. This
chart indicates the types of contacts with the various
taxing states which are considered sufficient to require
a corporation to file a return for a tax on or measured
by net income. In all cases the corporation is assumed
to have a place of business, including a factory, ware-
53
TABLE 3-2
NEXUS STANDARDS FOR STATE INCOME TAXES IMPOSED
ON FOREIGN CORPORATIONS
Contacts with Taxing State Number of Tax
Administrators
Considering the
Activity Suffi
cient contact
to Require
Filing a Return
Number of
Tax Admin
istrators
Considering
the Activ
ity Insuf
ficient
Contact to
Require
Filing a
Return
Sales Obtained through
Telephone or Mail Orders
(without Salesmen in the
State) and
Sales catalogs mailed
to prospective customers
in the State.
Goods exhibited at
space leased occasionally
and for short terms
Stock of raw materials
stored in the State
Administrative office
in the State
Research facility^ for
company use onlya in
the State
Realty in the State
producing investment
income
Sales obtained through in
dependent contractors with
offices accepting orders in
the State on corporation's
15
29
30
32
10
36
22
8
6
27
54 -
table 3-2— Continued
behalf and
No other activities 6 - -30
Goods in the state con
signed to customers 9 28
"missionary men" creating
demand for products 9 26
Salesmen regularly soliciting
orders in the State (without
authority to accept unless
otherwise indicated) and
No other activities 3 34-
Display ing goods at space
leased occasionally and for
short terms 9 18
Telephone answering service
in the State with local
directory listing 8 29
stock of goods in the State
from which goods (in public
are delivered in warehouse) 33 4
the State by (in private
common carrier warehouse) 36 1
Sales office in (with orders
the State accepted out
side the State)31 6
(with orders
accepted in
the State) 36 1
Salesmen residing in the
State using homes for
maintaining records only 10 26
Corporation qualified to
do business in the State 28 9
C.O.D. shipments (regularly) 9 28
into the State (occasionally) 5 32
55
TABLE 3-2:--Continued
Security interest
retained in goods
sold
(regularly)
(occasionally)
12
10
25
27
Credit investigations
and collections made
by salesmen
(regularly)
(oc c as ionally)
21
16
15
20
Cars in the State
owned by corporation
and used by salesmen
(regularly)
(occasionally)
14
10
23
27
Delivery of goods into(regularly)
State in company-oper-(occasionally)
ated vehicles
17
12
19
24
Installation or assem
bly of corporation’s
products by salesmen
.-(regularly)
(occasionally)
33
29
3
7
Acceptance of orders
in the State by sales
men
(regularly)
(occasionally)
25
19
12
18
Servicing or repair
ing of corporation’s
products by its
(regularly)
(occasionally)
(rarely)
27
22
12
7
13
22
employees at no
additional charge
Source: Adapted from H. R. l48o5 pp. 148-14-9.
56
house, and sales office, outside the taxing state and to
ship goods regularly by mail or common carrier into the
taxing state. At the time the information was gathered,
during the first half of 1 9 6 3* Indiana and West Virginia
had not yet enacted income tax laws; the chart accounts
for 37 states. Where totals are less than 37* an
administrator's reply was either unclear or not received.
Numerous qualifications were appended to replies some
times indicating that a situation constituted sufficient
nexus, but in actual practice a return was not required.
Or, the assertion of liability depended on the nature of
the products; or that tax liability in a given situation
was "probable."
There is no unanimity about any of the activities
listed. However, each Is considered a basis for juris
diction by at least one state and almost all are consid
ered to provide sufficient nexus by several states. This
chart covers only a limited number of activities in the
area of possible doubt, and situations arising in actual
practice are likely to be much more complex. In only a
few of the situations listed on the chart is the degree
of agreement among the states substantial. With the
exception of Delaware, ho state considered the mailing of
sales catalogs to prospective customers within the state
plus the in-shipment of goods as a liability-creating
activity. With the exception of New York, all the states
57
considered liability to exist if the corporation maintains
an in-state sales office at which orders are both solici
ted and accepted. With the exception of Wisconsin, all
the states considered liability to exist if the corpora
tion’s salesmen solicit orders in the state and the
orders are filled from a stock of goods stored in-state
in a private warehouse. Most of the other activities
covered in the table are subject to a substantial divi
sion of positions among the states, with a different
alinement of states to each activity.
An added difficulty is that even states with
nearly identical statutory language may not assert
liability under the same circumstances. For example, in
Wisconsin a tax is imposed on such income as is derived
from property located or business transacted within the
statej Oklahoma imposes a tax on the same basis. But
the Subcommittee questionnaire revealed that the Oklahoma
administrator has interpreted his statute to impose
liability where a company makes mail order sales and
maintains a research facility or stock of raw materials
in the state. The Wisconsin administrator does not assert
liability in these circumstances. This was one of many
14
similar instances involving many states.
In general, comprehensive statements of
J-^Ibid., p. 150.
statements of administrative positions with respect to
the circumstances in which liability is created are not
published* and neither the businessman or his tax
advisers can readily learn what claims are made by state
tax administrators. Moreover* there is much uncertainty
about underlying legal rules* casting doubt as to the
IS
sustainability of administrative positions. ^ The
conscientious businessman may volunteer to pay taxes that
may not be legally due; or he may decide not to file
returns and thereby maybe take a chance of exposing his
company to legal action. Since statutes of limitation
do not generally protect companies which do not file
returns* liabilities (plus interest and penalties) may
accumulate over a long period of time. Many companies*
if in doubt* wait to be called upon by administrative
officials. 16
Since the income tax is self-assessing and its
effective administration depends on voluntary compliance*
the fact that there is so often no clear answer as to
whether a return should be filed is indeed a problem.
Definition of Income
As has been stated before* any consideration of
state rules defining taxable income results in comparison
1 5Ibid.* p. 1 5 1.
l6Ibid.* p. 1 5 2.
59
with federal provisions. Just as the Internal Revenue
Code constitutes an extraordinarily complex body of law,
so also do comparable state laws. A thorough analysis
of variations between state and federal regulations
would be unnecessarily lengthy and complex. Sufficient
for present purposes is the summary which follows.
Types .of Relationships of state definitions to
the federal base. Each of the income tax states falls
into one of three groups with regard to statutory
methods used to define total corporate net income for
tax purposes: those using a moving federal base; those
using a static federal base; and those defining their
tax base independently of federal provisions.
In thirteen states a moving federal base is
used.The starting point for the computation of state
tax base is the taxable income required to be reported to
the federal government under the Internal Revenue Code as
It may be amended from time to time. The differences
between federal and state definitions are expressed in
the statutes as adjustments; for example, the state may
require that certain income taxes which have been deducted
in computing federal taxable income be added back in
computing the state's tax base. Still, the figures
^Alaska, Colorado, Connecticut, Delaware,
Massachusetts, New Jersey, New Mexico, New York, North
Dakota, Pennsylvania, Rhode Island, West Virginia.
60
reported by the taxpayer to the federal government will
necessarily reflect the basic ground rules of the state
law.
In five states, a static federal base is used.
The statutes of these states incorporate by reference
federal definitions of taxable income which were in
effect as of some particular date. Idaho uses the
1 Q
federal definition as of December 31j 1966] Kentucky,
December 21, 19 6 5 Indiana, January 1, 1 9 6 5; Iowa,
20
December 31s 1964 j and Hawaii, June 7, 1958. These
states all conform substantially to the current federal
base, since they adopt amendments to the Internal
21
Revenue Code from time to time. But their failure to
do so can, prospectively, present serious compliance
problems. Several instances are discussed below. The use
of a static base may reflect the reluctance of state
legislatures to provide for automatic adoption of changes
in tax law which they have not had an opportunity to
consider. Or it may reflect doubts about the propriety
^ State Tax Review, XXVIII, No. 18 (April, 1 9 6 7),
P. 3.
-^State Tax Review, XXVII, No. 14 (April 4, 1 9 6 6),
p. 2.
^ State Tax Review, XXVII, No. 46 (October 31*
1 9 6 6), p. 1.
Estate and Local Tax Service, (Prentice-Hall,
Inc., 1 9 6 6), p. 1004".
6l
under state constitutions of prospective adoption of laws
enacted by another legislative body.
In twenty-one states, net income is defined in
a manner independent of the definitions prescribed by
22
the federal government. While many of the provisions
in these states1 tax laws have been copied entirely or
substantially from federal provisions in effect at some
time, differences may occur at any point. The taxpayer
is required to determine the differences between the
state and the federal definitions.
Compliance aspects of differences in definitions
of taxable income. Moving-base states pose the fewest
compliance problems for the taxpayer; when changes in the
federal law are automatically incorporated by a state,
the taxpayer doesn’t have to master two bodies of law.
Moreover, the adjustments to federal taxable income which
are required by such states are usually simple and do not
necessitate any changes in basic bookkeeping methods.
In contrast, the other states' regulations do involve
mastery by the taxpayer of two bodies of tax law; and the
2 2Ibid., Alabama, Arizona, Arkansas, California,
District of Columbia, Georgia, Kansas, Louisiana,
Maryland, Minnesota* Mississippi, Missouri, Montana, North
Carolina, Oklahoma, Oregon, South Carolina, Tennessee,
Utah, Virginia, Wisconsin.
23H. R. 1480, p. 273*
nature of some of the variations between state and
federal provisions may require extensive additional work.
Problems are less significant where states have made
efforts to keep abreast of federal changes. Even so,
there may be lags; and the taxpayer must make it his
business to know how the tax base is defined by the
federal government and in each income tax state in which
operations are carried on. Even when a statute exhibits
a policy identical with that of a given federal provision,
the interrelation between the item and other items may
require the taxpayer to use different figures on federal
and state returns. For example, state and federal
provisions disallowing deductions for expenses related to
exempt income may be identical. But if the state exempts
different classes of income than does the federal govern
ment, the state rule may disallow amounts different from
those disallowed by the federal provisions. Furthermore,
whenever any item does not incorporate the federal pro
vision by reference, the taxpayer has the problem of
determining the similarities and differences between
federal and state regulations. He must also resolve any
question as to whether a difference is intended in the
application of a provision to particular facts.
Compliance problems resulting from differences
in tax base definitions may be nearly nonexistent, as is
the case with some moving-base states; or they may be
63
extensive, in states where the tax base is defined
independently of federal tax provisions. Perhaps the
most complicated of the moving-base states is New York.
It requires thirteen adjustments to federal taxable
income. Most of these, however, can be computed fairly
easily. The part of the New York statute defining net
income takes only a page and a half in one of the tax
services. This is in striking contrast to a state such
as California, which requires 82 pages to define its tax
base. And this does not take into account regulations
which have a tendency to reflect the size of the statute.
oh .
New York has one regulation; California has over 130.
Ease of compliance is not the only consideration
made when a state determines its degree of conformity to
the federal tax base. Many other policy considerations
may be relevant, but compliance problems must be taken
into account, as well as the ability of the state to
enforce effectively regulations wherever voluntary com
pliance is unlikely or in doubt.
Division of Income
Specific allocation, separate accounting, and
formula apportionment are the fundamental means used to
divide income among the states for purposes of corporate
net income taxation. Formula apportionment, the principal
2^Ibid.
method, involves the division of a taxpayer's net income
on the basis of a ratio of the economic activities or
values inside the taxing jurisdiction to the same
activities or values outside of it. Most states, as an
adjunct to formula apportionment, require the specific
allocation to themselves of the entire proceeds of certain
of the taxpayer's activities which they consider to be
connected with the taxing state and unrelated to his
general multistate business operations. After items of
income are specifically allocated, the remainder is
usually apportioned to the taxing jurisdiction by a form
ula. Wiereas formula apportionment and specific alloca
tion are broadly applied methods in any state using them,
separate accounting has only limited application. This
method involves treating the instate portion of an inter
state business as a separate entity doing instate business.
Table 3-3 summarizes state regulations with respect to
divisions of income.
Separate accounting. In more than three-fourths
of the income tax states there are broad, generalized
provisions authorizing separate accounting where the
prescribed method for the division of income produces a
distorted or inequitable resillt. In these states, the
presumption is in favor of apportionment and allocation
rather than separate accounting; and it is only upon a
finding by the administrator of inequity or distortion
TABLE 3-3
DIVISION OF INCOME FOR TAX PURPOSES, 1966
State Separate
accounting
Specific
allocation
Factors in apportionment formula:
Property Payroll Sales Other
Alabama allowed none X
---
X
Alaska
3
nonb. X X X
Arizona allowed nonb. X X X
Arkansas allowed nonb. X X X
California allowed nonb. X X X
Colorado
3
b. & nonb. X
---
X
Connecticut allowed nonb. X X X
Delaware allowed b. & nonb. X X X
District of
Columbia allowed nonb. X X X
Georgia allowed nonb. X X
Hawaii allowed b. & nonb. X X x^
Idaho allowed nonb. X X X
Indiana allowed nonb. X X X
Iowa allowed b. & nonb.
--- ----
X
Kansas allowed nonb. X X X
Kentucky allowed nonb. X X X
Louisiana allowed b. & nonb. X X X
Maryland allowed nonb. X X X
Massachusetts not
allowed nonb.
X X X
Minnesota allowed b. & nonb. X X X
TABLE 3-3— Continued
Mississippi allowed b. & nonb. X
x5 x<
Missouri allowed nonb.
— -------
X
Montana allowed nonb. X X X
New Jersey not allowed none X X X
New Mexico allowed nonb. X X X
New York
3
b. & nonb. X X X
North Carolina allowed b. & nonb. X X X
North Dakota allowed nonb. X X X
Oklahoma not allowed nonb. X
-------
X
Oregon allowed nonb. X X X
Pennsylvania allowed nonb. X X X
Rhode Island allowed none X X X
South Carolina allowed b. & nonb. X X X
Tennessee allowed none X
-------
X
Utah allowed nonb. X X X
Vermont
3
b. & nonb. X X X
Virginia allowed nonb. X X X
West Virginia allowed nonb. X X X
Wisconsin allowed b. & nonb. X
-------
X
1. Manufacturing costs.
2. Wages not a separate factor, but included in manufacturers' production cost factor;
not applicable to sellers in Tennessee.
3. No specific provision.
4. Only if principal instate activity is selling. c r »
5. Manufacturing labor only.
6. Sole factor for businesses other than manufacturing.
7. Investment income and capital treated separately.
TABLE 3-3— Continued
8. Cost of operation.
9. Certain alternate formulas allowed.
10. Tax effective July 1, 1967* (State Tax Review, XXVIII, No. 14 (March 28, 1 9 6 7, p. 1.)*
nonb: specific allocation of certain nonbusiness items only.
b. & nonb.: Specific allocation of certain business and certain nonbusiness items.
Source: Adapted from State and Local Tax Service3 (Prentice-Hall, Inc.,
September 27, 1966), pp. 1039-104-0•
o \
that separate accounting is allowed or required. A few
states prohibit its use altogether. In the states where
separate accounting is not favored, Subcommittee findings
2 5
indicated that it is permitted only rarely. Adoption
of the Uniform Division of Income for Tax Purposes Act by
several states during the last few years would seem to
point up a trend even further away from the use of
separate accounting. It is reasonable to conclude that
separate accounting is not very significant in terms of
the total tax base attributed to the states. It is also
reasonable to conclude that this method is used for only
a small proportion of the returns filed by multistate
taxpayers.
Specific allocation. Most income tax states use
specific allocation, in varying degrees, in conjunction
with formula apportionment. In specific allocation,
certain classes of income are regarded as being nonap-
portionable. Each such class is attributed on the basis
of special rules applicable to it. This method involves,
more directly than any other, an attempt to determine the
geographical source of particular income items. It also
illustrates vividly the fact that agreement on the
appropriateness of taxation by source does not necessarily
result in uniformity of state practice.
g5lbid., p. 161.
69
Application of the concept of specific allocation
by individual states results in disagreement at two levels:
1) the types of income to be specifically allocated; and
2) the determination of where a given type is to be
allocated. On the basis of the methods which they use
to determine what income is specifically allocable, the
states may be divided into three groups: those which rely
solely on an itemization of the particular types of income
to be specifically allocated; those which distinguish
between business income and nonbusiness income; and those
which distinguigh between unitary business income and
2 6
other income.
For those states which itemize, the types of
income not enumerated are apportioned by formula. But in
some states the classes of income are very comprehensive
and include up to a dozen items. In others, only one sort
of income is designated.
In states which distinguigh between business and
nonbusiness income, in order for income to be specifically
allocated it must not only be one of the types which is
listed; it must also be nonbusiness income. If an item
of income is considered business income, it is apportioned
by formula even though it is within the listed categories.
UDITPA defines business income as "income arising from
26Ibid., p. 198.
70
transactions and activity in the regular course of the
taxpayer's trade or business," including "income from
tangible and intangible property if the acquisition,
management and disposition of the property constitute
integral parts of the taxpayer's regular trade or business
27
operations." The classes of income which are to be
specifically allocated under UDITPA, if they do not
constitute business income for the taxpayer, are rents
and royalties from real or tangible personal property,
capital gains, interest, dividends, and patent or
28
c opyzright royalt ie s.
A few states distinguish between income received
in connection with a unitary business and income not con
nected with the unitary business. In such states all the
former is apportioned by formula; all income not so
received is specifically allocated. The unitary business
standard differs from the business income standard in
that particular income could be considered business
income but nevertheless not be considered income received
in connection with a unitary business. For example, a
diversified corporation owns a chain of clothing stores
in State A and State B. It also owns a hotel in State A
which uses a unitary business standard. State A would
2^Section 1(a) of the Act. The Appendix contains
the full text of UDITPA.
2^Section 4 of the Act.
71
probably not consider the hotel a part of the unitary
business on the ground that the profitability of the hotel
is sufficiently independent of the success of the clothing
stores that it would be considered a distinct one-state
business unit. However, in a state whose attribution
rules turned on whether the income was business or nonbusi
ness, the income from the hotel might well be considered
business income and included with the income from the
clothing stores in the corporation's apportionable income
After making the initial decision that income is
to be specifically allocated, it becomes necessary to
establish the state to which the assignment will be made.
Since the underlying theory of specific allocation is that
some types of income can and should be attributed
entirely to the source of the particular item of income,
the problem becomes one of locating the source of that
income. Standards currently applied by the states in
establishing such sources include: 1) the location of the
income-producing activity; 2) the location of the entity
which paid the income to the taxpayer; 3) the location of
the taxpayer; 4) the location of the income-producing
asset. The first two of these standards are employed by
only a few states. The other two— location of the tax
payer and location of the income-producing asset--are
29h . R. 1480, p. 200.
72
■widely used. One method of establishing the location of
a corporation is by reference to its state of incorpora
tion, or its legal domicile. Although this method is
simple and definite, it is not one which many states
follow. This is probably because it is fairly common for
corporations to be chartered in states where they have
little economic activity. If an item of income were
attributed to such a legal domicile, it would be allocated
away from the state where the corporation's activities
were conducted. Very few states use legal domicile as
the sole means of determining the location of the tax
payer for purposes of specific allocation.
A more popular method of establishing the loca
tion of a corporation is by reference to the state where
the corporation's commercial or economic activities are
considered to be centered. Such a state is commonly
referred to as the state of commercial domicile. This
may be where the corporation's management is centered, or
where the principal operations of the business are con
ducted. Some states don't use the term commerical domi
cile specifically, but employ language meaning the same
thing, such as "situs of the corporation, ” "principal
place of business," or "home office."
Another standard which is widely used in
determining the attribution of specifically allocable
income is the location ot the income-producing asset. All
of the states which specifically allocate income rely on
this rule to a greater or lesser extent. The standard
offers little difficulty in its application to tangible
property. When the income-producing assets consist of
intangible property such as accounts receivable, bonds,
copyrights or patents, the location of the asset becomes
far less certain. One method of locating an intangible
asset is to employ the fiction that it follows the person,
mobilia sequunter personam. This produces the same
result as allocating according to the location of the
taxpayer corporation as discussed above. A second method
is to assign the intangible to its own location. This is
called the business situs. Like commercial domicile, the
business situs concept provides a basis for the taxation
of income from intangible other than the state of incor
poration. The term is, in most state regulations, left
undefined. This has put the burden of working out what
the concept means on the courts, which have dealt with the
problem as they must— on a case-by-case basis.
Formula apportionment. The classes of income
which are apportioned by formula vary from state to state.
In some, apportionable income is equated with business
income; others use unitary business income, or income
remaining after the segregation of particular items of
3°Ibid., p. 203.
74
nonapportionable or specifically allocable income. A
few states apportion all income. Although differences
may be significant with respect to the inclusion of such
items as dividends, capital gains, and other items not
generally part of the operating income of the enterprise,
the definitions of apportionable income are usually
broad enough to include all income earned from the sale
31
of goods in the regular course of business.
Table 3-4 illustrates the diversity in formulae
used by the states. Although the widespread adoption of
the three-factor (property, payroll, sales) formula has
reduced the number of radically different formulas in
use, it does not mean that uniformity has been achieved
even among those states which have adopted it. The
significant variations from state to state in the sub
stance of the factors tends to destroy this surface
appearance of identity. There is fairly general agreement
on definitions of property and payroll factors; but a
variety of standards is used in assigning sales, of which
at least six major types exist: by destination (delivery
place), by sales office where negotiated, by shipment
origin, by sales activity (negotiating personnel), by
property at time of order, and by place of acceptance or
receipt of order. To complicate matters, some states use
31 Ibid., p. 168.
75
TABLE 3-4
APPORTIONMENT FORMULAE IN USE, 1 9 2 9 , 1948, I960, 1966
Number of states using in
1 9 2 9 1948 i960 1966
Three-factor:
Property-payroll-sales 2
15
24 301
Property-manufacturing
cost-sales 1
5
6 4
Two-factor:
Property-sales 1 4 2 1
Property-business factor 1 2 1 -
Manufacturing cost-sales - - 1 -
Property-manufacturing cost 1
3
■ - -
Prope rty-payroll 1 1
One-factor:
Sales 2
3 3
2
Manufacturing cost 1 1 - -
Property 4 — — -
No formula
3
- - -
Totals 16
33 37 38
3-Will be 31 when West Virginia's tax becomes
effective July 1, 1 9 6 7.
Sources: Charles E. Ratliff, Jr., Interstate
Apportionment of Business Income for State Income Tax
Purposes, Chapel Hill: University of North Carolina Press,
1 9 6 2, p. 29l and Prentice-Hall, Inc., State and Local Tax
Service, pp. 1039-40, dated September 2b, 1 9 8b. Where
different formulae are provided by a state for different
types of business, the one shown here is for the group
that includes manufacturing.
more than one standard in assigning sales. Over the last
dozen years there has been a noticeable trend toward more
widespread use of the destination standard. This may
be for several reasons $ the Uniform Division of Income
for Tax Purposes Act contains such a sales factor. This
sales assignment standard was chosen for UDITPA for two
reasons: the origin test was rejected by the National
Conference of Commissioners on Uniform State Laws on the
grounds that it would tend to duplicate the property and
payroll factors; and the destination test recognizes the
contribution of the consumer (less industrialized) states
toward the production of income. It may be that one
reason for states’ turning to the destination test
revolves around efforts to maintain a competitively
attractive tax climate. By allowing a locally based
manufacturer with a significant amount of sales outside
the state to attribute his sales by destination* the state
is able to offer him a lower tax bill than he would have
under an origin test* or a sales office test where the
sales office is in the taxing state. On the other hand*
the state also attributes to itself income from sales
32Por detailed information on standards used in
assigning sales* see H. R. 1480* pp. 120-121j and Prentice
Hall, Inc.* State and Local Tax Service, pp. 1043-1044*
dated October 4, 1 9 5 6 ~ .
33william j. Pierce* "The Uniform Division of
Income for State Tax Purposes," Taxes* XXXV (1957), p. 7 8 0.
77
destined into the state from manufacturers based else
where. The controversy surrounding the sales factor is
covered in a later chapter.
Among the thirty-nine income tax states* at least
three-fourths use a property factor,, a payroll factor*
and a sales or receipts factor. Despite this general
agreement as to the relevant factors for locating income*
there is great diversity in determining the proportion
of each factor which is to be attributed to a given
state. This diversity, and consequent inconsistency
among the states as to where a corporation should pay
tax* raises possibilities both of complex accounting
requirements and of overtaxation and undertaxation.
Rates
Table 3-5 shows the rates used by all of the
corporate income tax states in 1 9 6 6. Included are the
percentages for the years 19^8 * 1956* and 1 9 6 3. Because
of its significance to the amount of liability* the
allowance of a deduction for federal income taxes paid is
also indicated. This is probably the most important item
which serves to reduce the impact of a tax rate* but it
often happens that states at the high end of the rate
scale do not allow the federal tax to be deducted. States
may allow other exemptions* deductions* and credits which
would have to be taken into account in a detailed
TABLE 3-5
STATE CORPORATE INCOME TAX RATES FOR SELECTED YEARS, 1948-1966
1948 1956 1963 1966
Alabama
Alaska
Arizona
Arkansas
California
Colorado
No tax in effect
I ; $ 1st $3, 0 0 0*
2$ 2nd $1 ,0 0 0
2. 5# 3rd $1 ,0 0 0
3$ 4th $1 ,0 0 0
3. 5# 5th $1 ,0 0 0
4.5$ 6th $1 ,0 0 0
5$ balance
1| % 1st $3,0 00*
2% 2nd $3 ,0 0 0
3$ next $5 ,0 0 0
next $14,000
balance
3-4$
5$*
356*
3. 75$ 1st $2 5, 0 00!
6. 5$ balance
No change
Same, except
deduction for
federal taxes
not allowed
4#
4$*
5$*
5.4# 1st $2 5, 0 00!
9. 36$ balance
No change
No change
5.556
5$
5 5 6*
18$ of total
federal income
tax at rates in
effect 12/3 1 /6 3
1. 3$ 1st $1,0 0 0*
2.6$ 2nd SI,000
4.b$ 5th SI,000
5. 9$ 6th $1 ,0 0 0
6. 6$ balance
No change
5.5$
556
00
TABLE 3-5— Continued
Connecticut
Delaware
District of
Columbia
Georgia
Hawaii
Idaho
Indiana
Iowa
Kansas
Kentucky
3$
No tax in effect
5$
5*5$*
10$*
1. 5$ 1st $1,0 0 0*
3$ 2nd $1 ,0 0 0
4$ 3rd $1 ,0 0 0
5$ 4th $1 ,0 0 0
6$ 5th $1 ,0 0 0
8$ balance
No tax in effect
2$*
2$*
4$*
3.75$
No tax in effect
5$
10$*
1. 6$ 1st $1, 0 0 0*
3. 2$ 2nd $1 ,0 0 0
4.3$ 3rd $1 ,0 0 0
5.4$ 4th $1 ,0 0 0
6. 5$ 5th $1 ,0 0 0
8. 6$ balance
No tax in effect
3$*
2$*
5$ 1st $25,000*
7$ balance
5$
5$
5.25$
5$
5$
4$
5$ to $2 5 ,0 0 0
5* 5$ balance
10.5$*
5$
5$
5. 85$ to
2 5 ,0 0 0
• 435$ balance
6$
2$
3$*
3-5$*
No change
2$
4$
4.5$
No change
TABLE 3-5— Continued
Louisiana 4#* 4#*
Maryland 4#
5%
Massachusetts 6.215# 6. 76 5#
Minnesota 6%*
7.3#*
Mississippi 1% 1st $4,000
2# next $3,000
3# next $3,000
4# next $5,000
5% next $10,000
6% balance
2# 1st
3# 2nd
4# 3rd i
5# next
6# balar
|>5,000
> 5 ,0 0 0
>5,000
$10,000
ice
Missouri 2%* 2#*
Montana
3#* 3#*
New Jersey No tax in effect No tax in effect
New Mexico 2#* 2#*
New York
4.5# 5.5#
North Carolina 6% 6%
6 .7 6 5 %
10.23#*
2# 1st
3# 2nd
4# 3rd
4.5# ba:
$ 5,000
J>5,000
$5,000
ance
5.25^2
6. 765$
8.5#*3
2# 1st $5,000
3# balance
2#*
4.5#
1.75#
5.5#
6%
2#*
5 -5 % k
3.25#5
3#*
5 -5 %
6%
00
o
TABLE 3-5— Continued
North Dakota 3% 1st $3,000*
4% next $5,000
5$ next $7,000
6% balance
No change No change No change
Oklahoma > 4%* 4%* 4%* 4%*
Oregon Q% Q% 6% 6%
Pennsylvania 4% 6% 6% 6%
Rhode Island 4%
5: % 5% 5%
South Carolina
4 .5% 3% 5% 5%
Tennessee
3 -7 5 % * 3 .7 5 % * 4%
5%6
Utah
3%*
4%* 4%* 6%
Vermont 4%
5% 5% 5%
Virginia
3! % 5% 5% 5%
Nest Virginia No tax in effect No tax in effect No tax in effect 6%?
od
H
TABLE 3-5— Continued
Wisconsin 2# 1st $1,000*
2.5# 2nd $1,000
3# 3rd $1,000
3.5# 4th $1,000
4# 5th $1,000
5# 6th $1,000
balance
2# 1st $1,000*
2.5# 2nd $1,000
3# 3rd $1,000
4# 4th $1,000
5# 5th $1,000
6# 6th $1,000
7# balance
No change No change
-*-Rate is percentage of federal income tax; 12,5# in 1 9 5 6, l8# in 1 9 6 3.
2State Tax Review, XXVIII, No. 2o (May 9, 1967), p. 1.
3state Tax Review, XXVIII, No. 25 (June 6, 1 9 6 7), P* 2.
^State Tax Review, XXVIII, No. 14 (March 28, 1 9 6 7), p. 1.
^State Tax Review, XXVII, No. 25 (June 20, 1 9 6 6), p. 1.
^State Tax Review, XXVIII, No. 23 (May 23, 1967), p. 1.
"^Effective July 1, 1 9 6 7. State Tax Review, XXVIII, No. 14 (piarefab28, 1 9 6 7), p.l.
Source: 1948, 1956, 1963 figures from H. R. 1480, pp. 105-107.
1966 figures from State Tax Review, XXVII, No. 53 (December 19, 1 9 6 6),
pp. 10-14, except as otherwise footnoted. oo
assessment of the impact of rate structures. Table 3-5
in included to point up two trends in state corporate
income taxation over the last two decades. Tax rates
have been moving continually upward; and the increase
has been accentuated by a diminution in the extent to
which rate-reducing provisions, such as the allowance of
a deduction for federal taxes, have been permitted.
Revenues
In spite of the long-term tendency for corporate
income tax rates to increase and for deductions for
federal income taxes to be eliminated, the tax has tended
to decrease in its significance as a portion of the
revenue structure of those states that have had it for
any length of time. The absolute amount of revenue
produced by the taxes has shown a vast increase,
reflecting both the trends in the rates and the growth of
the economy; but the corporate income tax has not kept
pace with the increase in total tax collections in these
states. Looking at all states as a group, on the other
hand, the importance of the tax has been relatively
stable, with the effect of new adoptions offsetting its
decreasing importance in those states which haveuhad it
• a i j .
for some time,-'
Table 3-6 shows the revenue derived from the
3%. R. 1480, p. 108.
84
corporate net income tax in selected years beginning with
1927. It also shows total general revenues for all states,
total tax collections for all states and for the corpor
ate income tax states alone, and some percentage rela
tionships between these figures.
Since the yield of taxes measured by net income
varies with economic conditions, the ratio of corporate
net income tax collections to total tax collections in
income tax states shows a sharp drop during depression
years and a sharp increase during the boom years of
World War II. However, the tax has never regained the
position it had in the twenties.
In considering Table 3-6, it must be borne in
mind that the period referred to witnessed the spread of
the corporate income tax to more and more states. In
1 9 2 7, twelve states had such a tax, in 1 9 6 5* 38. In 1 9 6 7
this number stands at thirty-nine. While the ratio of
corporate net income tax revenue to total tax revenue in
all states remained about the same, the number of states
taxing corporate income more than tripled.
85
TABLE 3-6
REVENUE FROM STATE CORPORATE INCOME TAXATION SELECTED
YEARS, 1927-1965 (in millions of dollars)
1927 1938 1944 1951
General revenue,
all states $2 ,0 1 5
Tax collections,
all states 1 ,6 0 8
Tax collections,
corporate income
tax: states 435
Corporate net
income tax 92
Corporate net income
tax as percent of
general revenue 4 . 6$
Corporate net income
tax as percent of
total tax collections5♦
Corporate net income
tax as percent of
tax collections in
corporate income tax
states 21.1$
$4,141 $5,465 $12,402
3,132 4,071 8,933
2,390 2,754 6,123
165
446
6 8 7
4. 8.2$
5.5$
5.
11. 0$
7.7$
6. 1 6. 2$ 1 1. 2$
86
TABLE 3-6--Continued
1957
i9 6 0 1962
1965
General revenue,
all states $2 0 ,3 8 2
$2 7 ,3 6 3 $31,157
$40,930
Tax collections,
all states
14,531
1 8 ,0 3 6 2 0 ,5 6 1 2 6 ,1 2 6
Tax collections,
corporate income
tax states
9,935 12,699 14,579
19,274
Corporate net
income tax 984 1 ,1 8 0 1 ,3 0 8
1,929
Corporate net income
tax as percent of
general revenue 4.8$
4.3$
4.2$
4.7$
Corporate net income
tax as percent of
total tax collections 6. 8$ 6 . 5$ 6.4$ 7.4$
Corporate net income
tax as percent of
tax collections in
corporate income tax
states
9-9$ 9-3$
9.0$ 1 0. 0$
Note: Totals do not include the District of
Columbia; Hawaii prior to i9 6 0; and Alaska prior to 1959*
Sources: H. R. 1480, pp. 110-111; U. S. Bureau
of the Census, Department of Commeree, Compendium of
State Government Finances (annual series).
CHAPTER IV
THE TWO CURRENT PROPOSALS: THE INTERSTATE TAXATION
ACT AND THE MULTISTATE TAX COMPACT
Some of the undesirable aspects* the history* and
the extent of nonunifmrmity have been explored. This
chapter deals with current efforts to remedy the lack of
uniformity. As a result of the work of the Subcommittee
on State Taxation of Interstate Commerce* an Interstate
Taxation Act was presented to Congress. It was so
extensively criticized at hearings that it was replaced
by a second Interstate Taxation Act* which is now pending.
In response to it* the states have rallied behind the
Multistate Tax Compact* their own plan. In this chapter
the provisions of both are outlined and then compared.
The heaviest controversy centers on division of income—
specifically* the sales factor. Both sides of the
debate over the use of a receipts factor are covered.
87
88
The First Interstate Taxation Act: H. R. 11798
In June, 1965* the Special Subcommittee on State
Taxation of Interstate Commerce completed its final
report. A major result was H. R. 11798, named the Inter
state Taxation Act, introduced to Congress in October
of the same year. This was the first comprehensive
interstate tax law proposal, the only federal legislation
on the subject other than P. L. 86-272.^ The major
provisions are outlined below.
Jurisdiction
H. R. 11798 provided that taxes could be levied
only on corporations owning or leasing real property
physically present within the state, or having one or
2
more employees located in the state. Such persons must
perform all services in the state; or both within and
without, but with the latter incidental to the former; or
some services in the state, and with a base of operations
there. Jurisdiction would also be established if the
principal place from which business is conducted is in the
state, or if it is the company's legal domicile.^ The
-*-"An Analysis of the Net Income Tax Provisions of
the Interstate Taxation Act (H. R. 1 1 7 9 8), Vanderbilt Law
Review, XIX (March, 1 9 6 6), p. 527-
2Interstate Taxation Act, H. R. 1 1 7 9 8, 8 8th Cong.,
1 st Sess., October 22, 1 9 6 5, Section 101.
3ibid., Section 612.
last standard would be used if none of the others applied
to any state.
Definition of Income
The starting point for computation of state tax
base would be federal taxable income. This provides a
uniform moving-base rule. Each state could make adjust
ments in the computations, but none are permitted that
2 l
would favor local taxpayers over out-of-state taxpayers.
Division of Income
H. R. 11798 called for apportionment by a two-
factor (property and payroll) formula to be applied to
5
all income. Separate accounting and specific allocation
would be allowed only in rare and extraordinary circum
stances .
Administration
Although administration would still be largely in
state hands, the Secretary of the Treasury would pre
scribe rules, regulations, and forms to carry out uniform
ity. The bill set up a system of appeal for apportion
ment disputes, beginning with submission to an Apportion
ment Board of the Treasury Department. Appeal would
thereafter proceed as usual, moving next to the U. S. Tax
^Ibid., Section 212.
5Ibid., Section 201.
90
Court and proceeding ultimately to the U. S. Supreme
Court.8
Excluded Corporations
H. R. 11798 did not apply to transportation*
public utility* insurance* investment* or holding
7
companies; or to financial institutions. It also did
not cover personal income taxes or those on unincorpora-
Q
ted businesses.
Hearings on H. R. 11798
Support. Hearings on the bill began in January
of 1 9 6 6. Support came mostly from business interests;
especially mail-order firms* small multistate corpora
tions with only one business location* and some large
corporations which deal through franchisers within a
state.9 Their main objectives might be summed up as
follows;
1) low compliance costs;
2) fair and equal treatment of those similarly
situated;
^Ibid., Section 522.
7Ibid., Section 6 0 7.
8Ibid.* Section 531.
9Donald M. Bishop and Kerns Taylor* "The Proposed
Interstate Taxation Act*1' Texas Bar Journal* XXVTV* No. 4 -
(April 22* 1 9 8 6)* p. 307.
91
3) a minimization of market decisions (i.e.,
economic neutrality--business should compete on the
basis of price and quality of goods and services, not on
the basis of artificial tax factors);
4) payment to home state or locality; where the
taxpayer gets the benefits of taxes paid.10
All these objectives were considered to be steps
toward simplicity, uniformity, certainty, and equity in
the matter of interstate taxes. By limiting state taxing
power to those situations where the taxpayer has a
business location, Congress was going back to the practices
before Northwestern-Stockham; i.e., the original concept
of "doing business." Supporters of the bill felt that
this intention was based on common sense, and on the
11
power of states to enforce tax regulations. The
state would apparently have no power to tax if income is
derived solely from solicited orders without, for
delivery within, if there is no real property owned or
leased in the state. Such property was defined to exclude
inventories. If the base of operations is in one state
and the company sells in several others, only the first
10W. H. Horsley in "Analysis of Final Report of
Special Subcommittee on State Taxation of Interstate
Commerce," Bulletin of the Section of Taxation, American
Bar Association, XIX, No. 1 (October, 19b$), p. 133.
llMartimer M. Kassell in "Analysis of Final Report
of Special Subcommittee ..." (see Ftnt. 10 ), p. 142.
92
could tax. If a Court should interpret a sales office as
the company's base of operations* then the state could
1 P
tax. ^ But an employee could conceivably move into a
hotel* solicit orders* and incur no income tax for his
company. Moreover* there is no way under such provisions
to reach mail-order firms that solicit through phone calls*
television* and the mails. Corporations that base opera
tions in tax-free states and send employees out to
solicit would escape all taxes.
The regulations of the proposal are easy to
applyj clear* and eliminate the necessity of large numbers
of returns for small liabilities. There would be less
possibility of income being attributed to a state where
the corporation has no place of business. Piling is
probably rare in these cases at present, since it is
nearly impossible to enforce tax laws as they stand on
13
an equitable basis.
Supporters of H. R. II7 9S approved of the section
on administration because it seemed a more logical way to
control disputes between states. It had the advantage of
being not very different* for practical purposes* from
the present system. The reasons set forth for having
control of such matters rest with the federal government
12' ! An Analysis of . ... (see footnote 1)* op. cit.*
p. 538.
13ibid.* p. 539.
93
were that the present functions of the Treasury Depart
ment and the U. S. Tax Court are suited to the task; and
"both the agencies and persons in question have extensive
past experience and considerable expertise in this area.^
Opposition. Opposition to H. R. 11798 came
nearly unanimously from the states. Basically, their
tax administrators opposed the two-factor formula. A
good many of the ideas discussed here are a part of the
states' objections to federal intervention of any sort,
and should be kept in mind in connection with any
Congressional proposal. Tax administrators usually
believe that their respective states' apportionment
formulas provide the most income. Many administrators
are under pressure from local industry that tends to
favor some particular system; and some states do use taxa
tion to compete for business. Some officials may suffer
18
from inertia and/or Parkinson's Law. Occasionally, too,
tax administrators develop political aspirations and wish
to avoid controversial programs. For all these reasons,
state tax officials are reluctant to change established
practices
^ Tbid., p. 542.
Parkins on' s Law: work expands so as to fill the
time available for its completion. Efficiency measures
can eliminate work, and therefore the administrators of
same.
^Mortimer M. Kassell, op. cit., p. l4l.
94
With particular reference to the proposed appor
tionment formula, the states consistently opposed a two-
factor plan. The controversy over the inclusion of a
sales factor is taken up at a later point in this
chapter.
As was the case aifter the passage of P. L. 86-272,
state tax officials called the constitutionality of
federal action into question. They often looked to
Alexander Hamilton to back up their arguments:
A law for abrogating or preventing the collection
of a tax laid by the authority of a state (unless
upon imports and exports) would not be the
supreme law of the land, but an usurpation
of power not granted by the Constitution.17
A rather complete statement of the views of the
states was prepared by the Committee on State and Local
Taxes of the Section of Taxation, American Bar Associa
tion.1®
1) The Special Subcommittee on State Taxation of
Interstate Commerce reports that, as presently enforced
and complied with, state and local taxes don't impose
costs on multistate businesses that are materially differ
ent from those on local businesses.^ If the system were
^ Federalist Papers, No. 33* Cited in Bishop and
Taylor, op. eit., p. 3Q&.
■^"Report of the Committee on State and Local
Taxes," Bulletin of the Section of Taxation, American Bar
Association, XIX, No. 4 (July, 1966)", pp. 117-120.
Estate Taxation of Interstate Commerce, H. R. 952,
complied with, the Subcommittee assumes that costs would
be excessive. However, no definition of valid jurisdic
tion prerequisite to imposition of taxes is given in the
first place. Secondly, it is assumed that all multistate
businesses are exposed to multistate taxation, when in
fact a business may be jurisdictionally present in only
one state. And lastly, the criterion for excessive costs
is the relationship of tax liability to cost of compliance
which is certainly not a problem peculiar to interstate
commerce. A major premise of the Subcommittee was that
the existing diversity in the system has led to non-
compliance and to unreasonable compliance costs. This
amounts to a complete non sequitur. To contend that
interstate business is not incurring burdensome compliance
costs because of nearly universal noncompliance, but that
such would not be the case were they to comply, is
questionable. Without the former, determination of the
latter is pure conjecture. Arguing that states should
enforce laws better, and if they did it would lead to
undue burdens on interstate commerce, doesn’t bring the
subject within Congress' power to regulate commerce.
2) The legislation is allegedly designed to
Report of the Special Subcommittee on State Taxation of
Interstate Commerce of the Committee on the Judiciary,
House of Representatives, 8 9th Cong., 1st Sess., 1ST,..
(September 2, 19 6 5 )5 p. 1127.
eliminate four major defects.
a) Widespread noncompliance. The conclusions
drawn are unsupportable with evidence collected in
a year of confusion and uncertainty. (1959) The
Northwestern-Stockham decision caused many adjust
ments. The Subcommittee’s work doesn’t establish
any standard for resolving the question of com
pliance versus noncompliance.
b) Over- and undertaxation. The Subcommittee
did not find any indication that this is a major
problem,
c) Competitive advantage to local businesses.
This also was not found to be a major problem.
d) Erosion of taxpayer attitudes due to un
certainty, poor enforcement, etc. There is no
factual basis for the conclusion that taxpayer
attitudes differ from the usual one of minimizing
tax liability. The fact that a taxpayer feels
that a tax is unfair is no ground for noncompli
ance .
3) Even if the problems listed immediately above
did exist, federal intervention would not solve them.
Putting interstate business in Congressional hands would
be tax discrimination against local businesses and would
cause a significant loss of revenue sources.
97
4) The suggested legislation doesn't simplify
anything, except that curtailment of jurisdiction would
relieve some corporations of tax liabilities in many
states. In fact, the proposed legislation imposes a
federal administrative and review structure over the
existing state tax system.
5) States have made great progress toward uni
formity. Many have adopted the Uniform Division of
Income for Tax Purposes Act, and most use the federal
income tax base. Most of them permit a vendor with
minimal sales to file a return covering a longer-than-
usual period, and do not charge taxpayers for out-of-
state audits. Many have indicated that they would sup
port an interstate compact.
Support with modification. There were elements
favoring H. R. 11798 that nevertheless wanted changes
made in the bill. Those proposed by the United States
20
Chamber of Commerce were among the most extensive:
1) that the jurisdictional requirement be revised
to prevent state taxation of a company with employees
soliciting orders, and to allow taxation of a company
which maintains a stock of goods in the state;
2) that a three-factor formula be used, with some
changes in apportionment techniques;
20State Tax Review, XXVTI, No. 5 (January 31, 1966),
p. 2.
98
3) that federal administration not be required,
since controversies could be resolved with the existing
state administrative procedures and judicial remedies.
Some other suggested changes applied to taxes
other than those levied on income.
There were many suggestions for alterations from
both proponents and opponents of the bill. The advisory
Commission on Intergovernmental Relations recommended a
21
three-factor formula as presented In UDITPA.
The Present Proposal: H. R. 2158
Objections to H. R. 11798 were so numerous and
so widely held that a new bill was drawn up to supercede
it. In July of 1 9 8 6, a new Interstate Taxation Act,
H. R. 16491, was introduced in Congress. The changes
contained in the new proposition are not so sweeping as
the original ones. Since the b9th Congress adjourned
without acting on H. R. 16491* it was necessary for the
bill to be reintroduced in January, 1987* as H. R. 2 1 5 8.
Soon after that time the Subcommittee added several
amendments. This legislation, including amendments, is
P P
hereinafter referred to as H. R. 2 1 5 8.
21State Tax Review, XXVII, No. 19 (May 9* 1 9 8 6),
p. 2.
22See Appendix for text of H. R. 2158.
99
Jurisdiction
The jurisdictional standard in H. R. 2158 is like
that of P. L. 86-272; indeed, the latter law is specific
ally retained. It would still be the case that a state
could not impose a net income tax on persons soliciting
orders for acceptance and filling out-of-state. The same
is true with respect to soliciting orders in the name of
or for the benefit of a prospective customer of the
employer, if the customer fills orders from a point out-
23
side the state. A state could not impose a corporate
net income tax with respect to sale of tangible personal
property unless the corporation has a business location
24
in the state. The concept of maintaining a business
location in a state means owning or leasing real property
within the state; having one or more employees located in
the state; or regularly maintaining a stock of. tangible
personal property In the state for sale in the ordinary
25
course of business. Thus inventory is added as a
jurisdictional base. An employee is located in a state
if 1) the employee's service is localized in that state
23State Tax Review, XXVII, No. 33 (August 8, 1 9 6 6),
p. 1.
24 ^
Interstate Taxation Act, H. R. 2158, 90th Cong.,
1st Sess., 1 9 6 7, Section 101. See Appendix for text.
2^Ibid., Section 511•
100
(i.e., performed entirely therein, except for incidental,
service outside the state); or 2) the employee’s service
is not localized in any state but some of the service is
performed in that state and the employee's base of
operations is there. It is intended that the uniform
rules and interpretations developed with respect to
locating employees for unemployment compensation purposes
be applicable here. To clarify the question of con
tractors and extractors, employees of such businesses
working on a contract in a state are to be presumed
located in that state. Installing or repairing tangible
personal property incidental to an interstate sale is
distinguished from contracting, "incidental" meaning
2 6
insubstantial. The term had been called to question
as presented in earlier proposals.
Definition of Income
Under "Excluded Corporations" below, it is
pointed out that H. R. 2158 does not cover corporations
with an average annual income in excess of $1,000,000.
In determining a company's average annual income, taxable
income as defined in the Internal Revenue Code of 195^
is used. The averaging process requires computations
using from one to five years; but in any case the federal
2^Ibid., Section 513*
101
taxable income for each year, as determined under the
Internal Revenue Code of 195^-j is the amount employed.2" ^
This Code is the one currently used in federal income
taxation, but it has been amended many times since its
passage. H. R. 2158 makes no mention of amendments.
The tax base to which the apportionment fraction
is applied is the corporation's taxable income as deter-
28
mined under state law.
Division of Income
No mandatory uniform method for dividing income
among the states is prescribed; but those interstate
companies covered by the bill are protected by a maximum
limit on the percentage of income which can be taxed.
Such a company with a business location in more than one
state need pay no more tax to any state or political sub-
dividion than that calculated under a two-factor property
payroll apportionment formula. In determining the maximum
amount of income attributable to any state, the two-factor
apportionment fraction is applied to the corporation's
entire taxable income, the definition of which is according
29
to state law.
The property included must be real and tangible,
2?Ibid., Section 506.
2^Ibid., Section 201.
29Ibid.
102
owned or leased, excepting that permanently retired and
that rented out for a year or more. The value of
property located in a state where the corporation has no
business location is not included in the factor’s denomin
ator. Owned property is valued at original cost; leased
property at eight times the rental paid, with no deduc-
30
tions for subrentals received.
The payroll factor is calculated in familiar
fashion; the numerator is wages paid to employees in the
state and the denominator is total wages paid to all
employees in any state. Wages paid to the retired are
not included. Wages are defined according to federal
31
income tax withholding provisions.
Excluded Corporations
H. R. 2158 excludes corporations which are any of
the following: 1) those with an average annual income
in excess of $1,0 0 0,0 0 0; 2) personal holding companies;
3) those receiving more than 5 0 % of ordinary gross income
(as defined by the Internal Revenue Code of 195^j not
including capital gains and losses) from public utility or
transportation services, insurance contracts, banking or
from dividends, interest, or royalties. 32
3QIbid., Section 202.
33-Ibid., Section 203•
3 2Ibid., Section 5 0 6.
Additional Provisions
States would be forbidden to charge for any part
of the cost of conducting outside the state an audit fo4 r
a tax to which the bill applies.^3
There is no provision for federal administration
or supervision in H. R. 2158j but it is specifically
stated therein that there shall be a continuing evaluation
made of state progress in resolving the remaining diffi
culties from state taxation of interstate commerce. Such
evaluation is to be carried on by the Committee on the
Judiciary of the House of Representativesaand the
Committee on Finance of the Senate, acting separately or
jointly, or both. If after four years of enactment of
H. R. 2158 substantial progress is not made in resolving
S4
such problems, remedial measures are to be proposed.
Many objections were voiced against H. R. 2 1 5 8.
Other than the usual complaint that such a bill represents
too much federalism and a serious curtailment of state
powers, the major criticisms relevant to income taxation
were in connection with the optional two-factor apportion
ment formula. It was argued that the three-factor
formula is the predominant one already used by states.
The optional two-factor formula is supposed to lessen
33ibia.a Section 524.
3^-Ibid., Section 401.
104
compliance problems for small interstate firms taxable
in more than one state; but such a company would there
under have to master both the "state apportionment and the
federal formula in order to determine which generates the
lower tax. Moreover* no uniform rule for tax apportion
ment is provided; the offering of an optional two-factor
35
formula will mean less uniformity, not more.
- The Multistate Compact
In January of 1967, the same month in which
H. R. 16491 was reintroduced to Congress as H. R. 2 1 5 8,
the Council of State Governments proposed a Multistate
Tax Compact as an alternative to the federal bill.^ With
the cooperation of the National Association of Tax Admin
istrators, the National Association of Attorneys General,
and the National Legislative Conference, the Compact was
presented for consideration by the states. ^
The stated purposes of the Compact are much the
same as those of the federal legislation: to facilitate
proper determination of state and local tax liability of
multistate taxpayers, including the equitable
Estate Tax Review, XXVIII, No. 11 (March 9, 1967),
p. 2 8.
3^See Appendix for text of the Multistate Tax
Compact.
3?state Tax Review, XXVIII, No. 6 (February 7,
1 9 6 7), p . T
105
apportionment of tax bases and settlement of apportion
ment disputes; to promote uniformity or compatibility in
significant components of tax systems; to facilitate
taxpayer convenience and compliance in the filing of tax
returns and in other phases of tax administration; and to
OQ
avoid duplicative taxation. This Compact* like the
Interstate Taxation Act* covers several types of taxes
levied by states on multistate businesses; only the
provisions relevant to net income taxes are discussed
here.
Jurisdiction
Provisions with respect to what constitutes
jurisdiction to tax are not set out specifically. The
wording of various provisions indicates* however* that
nexus may be established by either or both a business
location (owning or renting of real estate or tangible
personal property within the state) or by sales made
within the state.^9
Definition of Income
The Compact makes no reference to determination
of taxable income in accordance with the Internal Revenue
Code; definition of the tax base is apparently left up
3®Multistate Tax Compact* Article I.
39Ibid.* Article III.
106
to the states, as is now the case.
Division of Income
Provisions covering division of income are similar
to those of the Uniform Division of Income for Tax Pur
poses Act. Rents and royalties from real or tangible
personal property, capital gains, interest, dividends,
or patent or copyright royalties, to the extent they
constitute nonbusiness income, would be specifically
allocated according to provisions contained in the Com-
4 - 0 4l
pact. All business income would be apportioned with
a three-factor (property, payroll, sales) formula. Pro
perty is defined in the usual way, except that rentals
paid by the taxpayer are computed less any annual rental
rate received from subrentals. The payroll factor, too,
is essentially the same as that contained in H. R. 2158.
The sales factor is based on a destination
standard. Sales are considered to be in the state if
delivered or shipped to a purchaser within the state,
other than the U. S. government; or if goods are shipped
^°I b i d Article IV.
^Business income is defined in Article IV of the
Compact as income arising from transactions and activity
in the regular course of the taxpayer's business and
includes income from tangible and intangible property if
the acquisition, management, and disposition of same
constitute integral parts of the taxpayer's regular busi
ness operations.
107
from an office, store, warehouse, factory or other stor
age facility within the state and the purchaser is the
U. S. government, or the taxpayer isn't taxable in the
state of purchase. This applies to all tangibles.
Sales of things other than personal tangible
property are in the state if the income-producing activity
is performed in the state; or activity is in and out, but
a greater proportion is in the state than in any other,
based on costs of performance.
If the allocation and apportionment provisions of
the Compact as outlined above do not fairly represent the
extent of the taxpayer's business activity in a state, the
taxpayer may petition for or the tax administrator may
require, with respect to all or any part of the taxpayer's
business activity, if reasonable: 1) separate accounting;
2) the exclusion of any one or more of the factors; 3)
the inclusion of one or more additional factors which will
fairly represent the taxpayer's business activity; or 4)
employment of any other method to effectuate an equitable
ho
allocation and apportionment of the taxpayer's income.
Any taxpayer in a party state may allocate and
apportion income according to the laws of that state, or
according to the three-factor formula as defined in the
Compact. The taxpayer may elect to use either procedure
^Multistate Tax Compact, Article IV.
108
in all or any one or more party states in any given year,
without reference to the election made in others. Every
party state would also he required to offer a short form
option for taxpayers whose only activities within the
state consisted of sales (i.e., no ownership or renting
of real estate or tangible personal property), and whose
dollar volume of gross sales made within the state is not
in excess of $100,000. Such a taxpayer could elect to
report and pay any tax due on the basis of a percentage
of such volume with each party state adopting rates which
would produce a tax which reasonably approximates the
tax otherwise due. The Multistate Tax Commission, not
more than once in five years, may adjust the $1 0 0 ,0 0 0
figure to reflect changes in the real value of the doll-
43
ar,
Administration: The Multistate Tax Commission
The Compact established the Multistate Tax
Commission, to be composed of one member from each party
state whojshall be the head of the state agency charged
with the administration of the types of taxes to which
this compact applies. Some of the Commissions powers
would be 1) to study state and local tax systems and
particular types of state and local taxes; 2) to develop
and recommend proposals for an increase in uniformity or
43ibid., Article III.
compatibility of state and local tax laws with a view
toward encouraging the simplification and improvement of
state and local tax law and administration; 3) to compile
and publish information to assist states in implementa
tion of the Compact and taxpayers in complying with tax
laws; and 4) to do whatever else is necessary to adminis
ter the Compact. The Commission would be supported
financially by the party states* with allocation of
amounts due in proportion to revenues collected within
44
each such state.
Whenever two or more party states have uniform
or similar provisions of law relating to an income tax,
the Commission may adopt uniform regulations for any
phase of the administration of such law* including asser
tion of jurisdiction to tax, or prescribing uniform tax
45
forms.
Any party state desiring to make or participate
in an audit of any accounts, books, papers, records or
other documents may request the Commission to perform the
audit on its behalf. The government(s) for which it
performs the service will reimburse the Commission for
actual costs incurred. The Commission may declaim to
perform any audit of its resources are insufficient or if
44
Ibid., Article VI.
^5ibid., Article VII.
the audit is impracticable. In no event would the
Commission make any charge against a taxpayer for an
audit
If a taxpayer claims that he has been subjected
to multiple taxation by two or more party states, he may
secure arbitration of an apportionment or allocation;
parties to the Compact are bound to consent to and to
comply with arbitration. The Arbitration Board shall be
. . composed of one person selected by the taxpayer, one by
the agency or agencies involved, and one member of the
47
Commission’s Arbitration Pan&l. ' The Compact would not
supercede or limit the Jurisdiction of any court of the
United States; the appeal procedure would remain as it is
at present.
The Compact would enter into force when enacted
into law or by any seven states, and would become effec
tive thereafter in any state upon enactment. Except for
this provision regarding enactment and the Article on
division of income, the Compact applies to subdivisions
(any governmental unit or special district) of states as
well as the states themselves. Any party state could
withdraw from the Compact by enacting a statute repealing
48
the same.
Ibid., Article IX.
^8Ibid., Article X.
Ill
Excluded Corporations
Excluded from the provisions of the Compact are
financial organizations (insurance companies, banks,
trust companies., saving and loan associations, credit
unions, etc.), public utilities, and any rendering of
purely personal services as an individual. *
The states were very anxious to avoid federal
legislation in this area, and acted quickly. Within
five months of the introduction of the Multistate Tax
Compact, eleven state legislatures had formally accepted
it, and bills to that effect were pending in at least
five others.
H. R. 2158 and the Multistate Tax Compact Compared:
The Sales Factor Controversy
Jurisdiction
The proposed federal legislation refers specifi
cally to corporations, and establishes tax jurisdiction
on the basis of a business location within the taxing
state: owning or leasing of real property, having one or
^9Ibid.9 Article IV.
5°State Tax Review, XXVIII, Wo. 25 (June 6, 1 9 6 7),
p. 5- Legislation has been enacted by Arkansas, Idaho,
Illinois, Kansas, Nebraska, Nevada, New Mexico, Oregon,
Texas, Washington and %-oming. Bills are pending in
Florida, Michigan, Missouri, Pennsylvania and South
Carolina.
112
more employees* or maintenance of a stock of goods to be
sold. The Multistate Tax Compact is broader in its
coverage; it includes corporations, partnerships, firms
associations * and any governmental unit or agency or
person as a business entity. Jurisdiction is determined
by each state, as provided in the respective laws thereof.
The Compact does not specifically delineate any juris
dictional requirements, but division of income regula
tions indicate that any business activity, and certainly
sales made to residents of a state, can constitute
taxable nexus.
Excluded Corporations
H. R. 2158 excludes more types of corporations
than does the Compact. Both list public utilities and
financial organizations, but the federal proposal also
excludes transportation companies (the Compact counts as
a public utility any rate-regulated transportation
company); personal holding companies; corporations with
taxable income of more than $1,0 0 0,0 0 0; and those de
riving over half their income from dividends, interest,
or royalties. The Compact excludes any rendering of
purely personal services as an individual. It does not,
however, impose any size limitation on the firms covered
by its provisions; it includes all companies but those
types specifically mentioned, regardless of sales volume.
113
Administration
The Congressional legislation makes no mention of
any administrative machinery except for a Congressional
evaluation of states' progress four years after enactment
of the bill, with appropriate measures (if any) to be
determined at that time. The Compact establishes a
Multistate Tax Commission which is described at length
along with an arbitration procedure in case of disputes.
Audits
The Interstate Taxation Act states that a state
may not charge any taxpayer for expenses incurred in
making an out-of-state audit. The Compact has no such
provision. The Commission would conduct such audits at
no expense to the taxpayer, but it might also refuse to
perform an audit, at its own discretion. This article of
the Compact, like the others, would be in effect only in
party states.
Enactment
Those states which did not choose to enact
statutes of adoption would not be governed in any way by
the Compact. It would become effective for party states
when accepted by seven of them, and thereafter as acted
upon by additional states. The approval of Congress is
also necessary. The federal proposal would become
114
effective upon enactment by Congress, but the provisions
as to corporate net income taxes would apply only with
respect to taxable years ending after the date of enact
ment. Assessment of taxes after enactment for any
period ending on or before such time, if the taxpayer
wasn’t previously liable for the tax in question would be
disallowed.
Division of Income
Certainly the major source of disagreement bet
ween the supporters of the two proposals is the method of
dividing income. The Interstate Taxation Act makes no
reference to specific allocation or separate accounting.
A corporation's entire taxable income, as determined
under state law, is apportioned. The amount of the tax
cannot be in excess of the amount determined by the
application of a two-factor (property, payroll) formula.
The property factor is like that specified in the
Multistate Tax Compact, except that no deduction is
allowed for amounts received by the taxpayer for sub-
rentals of leased property. The payroll factors are
substantially alike.
The Compact allows for allocation of nonbusiness
income, and explains how this is to be accomplished.
Business income is then apportioned with a three-factor
formula (property, payroll, sales). The sales factor
115
standard for attribution is destination and covers sales
of tangible personal property as well as those other than
sales of such property. This receipts factor is defined
as is that in the Uniform Division of Income for Tax
Purposes Act. In general terms, a sale of tangible
property is considered to be assignable to a state if
said property is shipped to a purchaser in that state.
Sales other than sales of tangible property are assigned
to a state if the income-producing activity is performed
in that state.
Support for the sales factor. Proponents of
such a formula argue that a sales factor based on des
tination is justifiable, administratively workable, and
jurisdictionally clear. The latter two are practical,
political considerations. The justification is based upon
the theory that it is the market that gives realization
to income. A destination sales factor recognizes the
demand side of transactions. The sale, not the production
creates income; without it, there is no income to tax.
Crediting income from sales to the state of origin of
shipment (as is the case in some states) or elimination
of the sales factor favors "industrial" or "manufacturing"
states, as opposed to "consuming" or "marketing" states,
according to supporters of the destination standard.
These terms refer to whether a state is a net exporter or
net importer of manufactured goods. The contribution of
116
the state of origin* as well as location of selling
activities (another standard used in assigning sales)*
are covered in property and payroll factors. The labor
and capital involved are already represented.^ 1 Both the
payroll and the property factor favor the place of manu
facture ; the weight of the sale should be reflected at
the place of marketing* where the profit is captured.
The position that wealth is all created by labor and
capital, making the sales factor redundant* allegedly
ignores the fact that the tax is imposed on income— not
wealth— after the sale. Moreover, the property and payroll
factors tend to compound the burdens of local excise and
ad valorem taxes.
It is nearly universally agreed that a property
factor reflects a significant aspect of income creation.
Production* warehousing* and to some extent selling and
administrative operations* require property investment.
The payroll factor also reflects these activities* but
weights them differently and is thus also a desirable
factor. Supporters of the sales destination standard
argue that neither factor reflects adequately the impor
tance of selling activity in the earning of income. The
^John N. Wilkie* "Interstate Apportionment of Busi
ness Income," Taxes* XXXVIV* No. 4 (April* 1 9 6 1)* p. 3 5 6.
^2Pred L. Cox* "The MCCUSL Uniform Apportionment
Formula," Taxes* XLII* No. 8 (August* 1964), p. 534.
117
idea that income is earned only by services and by pro
perty so that payroll and property should be the only
allocation factors is anchored in classical economic
analysis of the factors of production. This analysis is
not appropriate to the determination of where net income
arises for tax purposes. Taxation is a pragmatic matter
which should deal with the business world on its own
terms. Factually* it is selling which converts the goods
produced into the income which is taxed* and the business
world regards selling activity as contributing substan
tially to net income. By the traditional standards applied
in income taxation by the federal government and most
nations* income from sales of personal property is
generally considered to arise where the sales transaction
is effected.
The merit of a uniform allocation formula should
be judged partly by ease of compliance; reduction of
compliance costs is one of its major purposes. Judging
the sales factor by this standard again recommends the
destination basis. The keeping of records and processing
of sales data to determine sales allocation would require
little effort on a destination basis. The manner in which
most companies1 sales records are normally kept make them
53Leonard Kust* "State Taxation of Interstate
Income: New Dimensions of an Old Problem*" Tax Executive*
XII, No. 1 (October* 1959)* p. 6l.
118
readily susceptible of determination of destination.
Sales analyses on a market basis are likely to be made
for management purposes in many cases and can be used
directly for tax purposes, thus requiring no special
effort. This is not so likely to be the case with other
54
standards for the sales factor. So go the arguments
of those who favor inclusion of a destination sales
factor in any uniform apportionment formula.-^
Opposition to the sales factor. Critics of the
sales factor suggest apportionment on the bases of payroll
and property only., so that each state would taxoonly its
own territorial values, with no necessity of looking at
thousands of sales invoices. The major arguments
against the use of a sales factor are the following.
1) The sales factor is the major source of com
pliance costs, and this would still be so with a uniform
apportionment formula. For many businesses, no sales
factor would be jurisdictionally clear. Some companies
5^Ibld., p. 63.
55p0r additional statements in support of the
destination sales factor, see Fred L. Cox, "The Inter
state Tax Problem," Taxes, XXXVIII, No. 5 (May, i9 6 0), p.
422; Charles F. Conlon, ’ ’ ’ The Apportionment of Multistate
Business Income," Tax Executive, XII, No. 3 (April, 1 9 6 0),
pp. 229-30; Arthur D. Iynn, Jr., "The Uniform Division of
Income for Tax Purposes Act Re-Examined," Virginia Law
Review, XLVI, No. 6 (October, i9 6 0), p. 1267; John A.
Wilkie, o£. cit., pp. 354-57.
119
ship to distributers and cannot always get records of
final sales; for some, keeping records of locations of
buyers is impossible.
2) Inclusion of such a factor assumes that the
labor and capital devoted to sales are more productive
than other kinds, and that net income from sales may be
all taxed in the state where one aspect of the selling
process goes on; it would be just as fair to devote one-
third of the apportionment formula to research or to
56
manufacture.
3) Among the states levying income taxes, about
75 items or definitions are used singly or in combination
to determine receipts for apportionment formulae; the
popularity of the three-factor formula is absolutely no
indication of uniformity. Elimination of the sales fac
tor altogether would lead to less disruption than imposi
tion of any uniform one; even with a uniformly-defined
concept of the receipts factor.
4) The concepts of states being either industrial
or market-oriented is disappearing, and is no longer
valid as a basis for decisions relative to the sales
factor.
5) Some critics add that the destination sales
56
Arthur B. Barber, "State Taxation of Net Income
Derived from Interstate Commerce," American Bar Associa-
tion Journal, XLVIII (December, 1 9 6 2), p. 1137- ~'
120
factor is poorest of all possible ones, since it assumes
that the purchaser consumes in the state to which goods
are sent. This point'is related to the first criticism
above. It may be a warehouse state, with no consumption
therein of the product in question. It has even been
suggested that if a company has no capital or labor in a
state, but pays taxes because of sales made there, then
this is a tax on the privilege of engaging in interstate
57
commerce. Such taxes are, of course, unconstitutional.
6) The sales factor not only adds to corporation
compliance problems; it also increases state collection
costs. It is much more difficult to check up on defin
itely than are either payroll or property values.
7) The sales factor results in violation of
C-O
horizontal equity (equal treatment of those in equal
positions), because effortiis not sufficiently high,
there is no attempt to collect the tax. A long-standing
canon of good tax practice is that rules should be certain
59
and not arbitrary. Since the taxes in question are so
5 7Ibid., p. 1 1 3 8.
^Richard A. Musgrave, The Theory of Public Finance
(New York: McGraw-Hill Book CompanyJ—Inc77~T^597T-^ -~l^i T
59Adam Smith, An Inquiry into the Nature and Causes
of the Wealth of Nations, 4th ed. (London: Methuen,
1904), Book V, Ch. 2, parts 1 & 2.
121
difficult to enforce, excessive administrative discretion
must be exercised in the selection of companies to be
taxed. Rules are applied in an unpredictable and often
discriminatory manner. This situation is very harmful to
6 0
the general tax compliance attitudes of businessmen.
8) Sales to residents in a state don't involve
costs to the state itself, especially when the selling
transaction takes place outside the state. Market states
argue that they provide benefits to companies selling
within their borders, but such benefits are not direct.
The States wouldn't protect foreign corporations if the
Constitution did not require that they be treated in a
non-discriminatory way. It has been argued that the
destination sales factor is a violation of due process on
the basis that a tax on an extraterritorial value can
never have a "real and reasonable" relation to the
privileges, opportunities and protection enjoyed within
62
the taxing state.
9) Taxing states are hesitant to admit that the
Paul Studenski, "The Weed for Federal Curbs on
State Taxes on Interstate Commerce: An Economists View
point," Virginia Law Review, XLVI, No. 6 (October, i9 6 0),
p. 1137.
r-.
Ibid., p. 1129.
DtFloyd E. Britton, "State Taxation of Extrater
ritorial Value: Allocation of Sales to Destination,"
Virginia Law Review, XLVI, No. 6 (October, i9 6 0), p.ll64.
type of levies in question are for the purpose of improv
ing the competitive position of their own producers;
imposition of such taxes amounts to a tariff on out-
63
siders. It is taxation of the privilege of shipping
goods into the state, measured hy income earned outside
the state. This is comparable to an import duty except
that it is payable after instead of at the time of ship
ment. Shipment into a state is a privilege conferred and
protected by the commerce and due process clauses, not by
the state into which shipment is made. These taxes also
give substantial tax exemption to home industry with
respect to income actually earned in the state when pur
chasers are outside the state. Obviously, the consumer
64
states stand to gain. One way or another, a state must
export as much as it imports. Some are richer than
others, but sharing the wealth can't be accomplished by
applying the market state concept. Another questionable
rationale is the inducement to manufacturers to establish
permanent facilities in the taxing state. Smaller com
panies may beivimore likely to .just stop doing business
65
there.
^3studenski, o£. cit., p. 1140.
Britton, oj>. cit., p. 1168.
^studenski, loc. cit.
123
A good part of the sales controversy is over what
it is that earns income, a disagreement at least as old
66
as Alfred Marshall's scissors illustration. Tfre
theoretical position of those opposing use of a sales
factor has been succintly stated by C. Lowell Harriss.
. . . But use of the sales (receipts) factor
had little--or no— economic justification.
Human effort produces income. Use of pro
perty produces income. Selling and purchasing,
however, do not produce income except as human
effort and property are involved. Although
selling is, of course, a part of the income-
creating process, its contribution is represented
not by the dollar volume of sales, but by the
remuneration of the human and material resources
that perform the selling function. To assign
sales an independent importance is to depart
from economically proper apportionment.°7
Advocates of the sales factor also base their arguments
on both theoretical and practical grounds. As for the
former, interpretations like Jarriss' are classified as
controversial, classical economic thought, contradicted
by utility theory. With respect to practical, political
considerations, it is argued that such ideas have no
bearing on tax policy and are contrary to tax postulates
68
widely used in the United States.
^Alfred Marshall, Principles of Economics, (London:
The MacMillan Company, 193&)* p. 34b.
6?C. Lowell Harriss, "Interstate Apportionment of
Business Income," American Economic Review, XLIX, No. 3
(June, 1959)> P* 460.
^^Jerome R. Hellerstein, "Allocation and Nexus in
State Taxation of Interstate Business," Tax Law Review,
XX (January, 1 9 6 5), p. 275*
124
And so goes the battle. On theoretical grounds,
economists tend to favor elimination of the sales factor;
its inclusion gives undue weight to the property and
payroll devoted to selling. It is condemned also on the
grounds that it interferes with the efficient allocation
of resources, increasing the real cost of goods, by in
ducing firms to manipulate their selling operations for
tax advantages and by imposing upon them more compliance
effort and cost.
Some of the destination sales factor advocates
argue that the seller is exploiting the market. This
may amount to an oversight of the fact that consumers
voluntarily exchange purchasing power for things of
value. If exploitation is taking place because of mono
poly elements, this is a matter for antitrust action
rather than recoupment by the state through taxation.
These arguments are usually advanced in an attempt to
Justify a market state in its actions to increase the
size of its tax base by extending its tax power to income
created by activities outside its borders and by en
couraging the location of manufacturing operations within
the state.^
69charles E. Ratliff, Jr., Interstate Apportionment
of Business Income for State Income Tax Purposes, (Chapel"
Hill; The University of NorthrCarolina Press, 1§62), p.
125
Revenue Impact of the sales factor. Certainly,
the fear of potential revenue loss is a prime reason for
states' insistence on a sales factor. Among the efforts
so far made in estimating the effects of imposition of
uniform apportionment formulae, both without and with a
sales factor, the most extensive were carried out by the
Special Subcommittee on State Taxation of Interstate
70
Commerce. In terms of revenue impact, the detailed
analysis undertaken by the Subcommittee indicated that
the importance of choice among division-of-income rules
is very much smaller than has been supposed. It is true
that the industrial states tend to benefit from formulae
which emphasize the location of property and payroll,
while the nonindustrial states tend to benefit from
formulae emphasizing the markets to which goods are
shipped. But the amount of revenue benefit involved is
very much smaller than that which would be suggested by
the fact that some states are very highly industrial and
others highly nonindustrial. It appears that if a choice
were made among three possible uniform formulae— property
and payroll with a sales-destination factor, a sales-
origin factor, and with no sales factor— for 26 of the
income tax states, less than one-half of one per cent of
total tax revenues would be involved in the choice; and
that for only one of the income tax states (Idaho) would
slightly more than one per cent of total tax revenues be
involved.
The small amount of revenue which turns on the
choice among formulae reflects several factors. To a
large extent, it reflects the fact that the corporate
income tax itself is a much less important revenue source
at the state level than at the federal. The few states
in which the choice of one formula over another could
produce a significantly larger tax base from manufacturing
and mercantile corporations in percentage terras, more
over, are states which rely even less heavily on the
corporate income tax as a revenue source than the income
tax states as a group. Manufacturing is an unimportant
part of the structure of these states' economies. For
them, although a choice among apportionment formulae may
mean a large percentage change in the taxable income from
manufacturing and mercantile corporations, the taxable
income reported under any apportionment formula will be
small.
Apart from the fact that the amounts of tax money
involved are small, no national policy with respect to
the desirable distribution of tax revenues among the
states appears to be at stake in the choice of formulae.
No formula seems to be a device well calculated to favor
the poorer sections of the country. While there is some
tendency for the industrialized states to have average
per capita incomes somewhat higher than those for the
127
nation, the correlation "between the degree of industrial
ization and the average per capita income is of an in
significant magnitude.
In addition, while the revenue impact of choice of
formula is today very small, it seems likely to become
even smaller in the years ahead. There has been a
gradual trend for the economies of the states to become
more similar in their composition. If this trend con
tinues as expected, the revenue importance of choice of
formula will gradually diminish for most of the states.
As a factor to be weighed in choosing among al
ternative uniform schemes for the division of income,
revenue considerations are minor. The Subcommittee's
report concluded that if a choice among formulas is to be
made, it can be made primarily on the basis of other con
siderations .
A widespread complaint about these findings was
that revenue differences for a given state should have
been compared with total collections from manufacturing
and mercantile companies, not with total tax revenues.
The method of comparison employed minimized the impact of
different formulae because total tax revenues include
monies collected by states and distributed to local units,
as well as earmarked funds (e.g., highway taxes). It
would be fairer to measure the revenue impact against the
128
70
particular tax revenues affected. North Dakota, for
instance, would suffer a reduction in corporate income
taxes collected from manufacturing and mercantile corpora
tions of an estimated 4-7$. Three states would lose more
than 20# of their respective revenues of this type; six
71
others would lose more than 10#.
Because of some of the difficulties involved in
makigg the estimates of revenue effects of different
uniform formulae— assumptions, gaps in data, omissions—
72
the conclusions drawn have been called into question.
Since the matter of revenue impact is just one considera
tion among many in arriving at an apportionment formula,
it may be prudent to treat the conclusions of the Sub
committee’s study as a framework which provides perspec
tive to one part of the picture.
7°Clarence ¥. Lock, "A Moderate's Viewpoint on
State Taxation of Interstate Commerce," The Tax Executive,
XVII, No. 4 (July, 1965)3 p. 325.
^Jerome R. Hellerstein, "Allocation and Nexus in
State Taxation of Interstate Business," State and Local
Taxes on Businesses, a symposium conducted by the Tax
Institute "of America, October 3 8-^0, 1964, Princeton:
Tax Institute of America, 1965-, P- 79*
7 2Ibid., pp. 74-90.
CHAPTER V
AN ECONOMIC APPROACH TO CORPORATE INCOME TAXATION
AT THE STATE LEVEL
It is appropriate at this point to look behind
tax practice to tax theory; specifically, to an evalua
tion of the state corporate income tax. A discussion of
the burden of the tax and how it is distributed will lay
the groundwork for construction of a theoretically sound
apportionment formula. Next, the economic effects of the
corporate income tax will be explored; and lastly, its
degree of equity. The question of equity revolves around
two principles, ability to pay and benefits received, both
of which contribute to an evaluation of the state corpor
ate income tax.
The Theory of the Net Income Tax on Business
Shifting of the Corporate Income Tax
Alfred Marshall observed that ’ ’ there is scarcely
129
130
any economic principle which cannot be aptly illustrated
by a discussion of the shifting of the effects of some
taxes . . . . Whatever the reasons for or justification
of the corporate income tax, the crucial question is that
of the incidence of the tax— who bears the ultimate
monetary burden?
Traditional economic analysis teaches that a
corporation income tax cannot be shifted. A tax which
takes a constant percentage of net income will not effect
the optimum level of output or price, since the output
level which yielded the greatest profit before the tax
will continue to do so after the tax. Neither marginal
revenue nor marginal cost are affected by the tax. Im
plicit in this analysis is the assumption that the tax is
confined to pure profit, and that firms maximize profits.
This is a fixed-capacity (short run) analysis. Classical
theory arrives at the same conclusion for a variable-
capacity (long run) situation. An income tax does not
affect marginal firms, which have no income, and therefore
forces none of them out of business. It also does not
change the optimum size of a firm with profits; the opti
mum before the tax still gives maximum profits after the
tax. The tax is confined to pure profit, and so exercises
1Alfred Marshall, Principles of Economics, 8th ed.
(London: MacMillan & Co., Ltd., 1930) p. 413.
131
2
no influence on investment policies of new or old firms.
Even with respect to the short-run conclusion,
traditional theory provides little more than a good point
of departure. The corporate net income tax is on business
profit, not economic or pure profit; and theory shows
that some shifting can occur. In the short run, situa
tions involving the return to working capital, or col
lective bargaining where the firm's ability to pay is
taken into consideration can cause adjustments in price
and output. Many businessmen regard the tax as an ele
ment of cost, and look to a planned rate of return after
taxes.
In the long run, the tax may act on the supply of
^capital and entrepreneurship. Even part of the tax on
economic (pure) profit might be shifted because of im-
pgrfect competition, inflationary trends, full-cost or
4
markup pricing, and anti-competitive agreements.
2
Due, Government Finance, pp. 215-223> Richard
Goode, The Corporation Income Tax, (New York: John Wiley
and Sons, Inc., 1951)* pp. 47-54j Shultz and Harriss, op.
cit., pp. 1 7 3-1 7 6, 329-330; Harold M. Somers, Public
Finance and National Income, (Philadelphia: The Blakiston
Company, 1945), pp. 207-226.
^Dan Throop Smith, Federal Tax Reform, (New York:
McGraw-Hill Book Company, Inc., 1961), p. 190.
^Musgrave, o j d . cit., p. 2 8 6; Shultz and Harriss,
op. cit., pp. 330-331; and see Harold M. Somers, "The
Place of the Corporation Income Tax in the Tax Structure,"
National Tax Journal, V, No. 3 (September, 3.952), pp. 279-
2 S 5 ~ -
132
Empirical investigations have not resulted in a consensus
5
of opinion. The majority view seems to be that at least
£
some of the corporate income tax is shifted. The fact,
among others, that the rate of return on investment after
taxes in manufacturing follows an almost level trend line
over the past several decades has influenced many to
conclude that, in the long run, corporate income taxes
7
are not borne by the owners of the business.
Several factors peculiar to the state corporate
income tax affect its shiftability, as compared to the
federal tax. In several states there is a supplementary
capital stock tax that establishes a minimum tax liability
for corporations earning no net income, and this can
8
operate to increase the degree of shifting. On the other
hand, variations in the business tax burdens (this
includes all business taxes) imposed by different states
5 A number of these studies are discussed in B. U.
Ratchford and P. B. Han, "The Burden of the Corporate
Income Tax,1 1 National Tax Journal, X, No. 4 (December,
1957), pp. 3101324“ .
g
Due, Government Finance, p. 223; Musgrave, op.
cit., p. 286; Shultz and Harriss, o£. cit., pp. 329-530;
Smith, o£. cit., p. 191; Somers, oj>. citT, p. 226.
7Eugene M. Lerner and Eldon S. Hendricksen,
"Federal Taxes on Corporate Income and the Rate of Return
on Investment in Manufacturing, 1927-1952," National Tax
Journal, IX, No. 3 (September, 1956), PP- 193-202.
Q
Charles E. Ratliff, Jr., Interstate Apportionment
of Business Income for State Income Tax Purposes, (Chapel
Hill: University of North Carolina Press, 1962), p. 84.
133
result in inequalities which may not be offset by the
quality of government services. Complete shifting of
taxes levied by the heavier-taxing states may be impos
sible when such states’ industries compete in a common
market with those of low-taxing states. The difficulty
in shifting results from the inequality of burdens im
posed on particular enterprises located in different
states but directly in competition with each other.^
The distribution of the corporate income tax bur
den is apparently haphazard. The tax is carried in some
degree by consumers., suppliers,, employees, stockholders.
It is not the same tax (i.e., as far as rates and base)
in every state, and not all states .levy such a tax. Its
effect is altered by the existence of other business
taxes in some states. A list of qualifications like these
could be long indeed. The relevant question is this:
given general agreement on the need for uniformity in
state corporation taxes, and in the light of our informa
tion on tax shifting, what sort of apportionment formula
is sound in theory and workable in practice? This is the
crux of the controversy surrounding interstate taxation,
the one point upon which the disagreement is consistent
and vehement.
^Shultz and Harriss, 033. cit., p. 330.
The Theory of Apportionment
If the incidence of the state corporate income
tax could be pinpointed and information as to the relative
distribution of the burden obtained, an apportionment
formula could be devised that would tax corporate income
accordingly. The factors included in the formula could
be weighted according to the portion of the tax borne by
each group included. This approach is unwise for many
reasons. The information needed is not available in the
first place, or at least is very difficult to obtain.
The factors that would have to be included would be more
problematical than the ones already in use; equity capital
and possibly company purchases would have to be accounted
for if firms were doing any backward shifting to
suppliers. This technique would not be as accurate as
individual income and sales taxes, since (given such
things as differing tax rates) a state's revenue from a
corporation would not necessarily equal the amount of
tax burden on individuals in that state.^ Moreover, the
tax would be distributed among Individuals with no
reference to their ability to pay. The only redeeming
feature of corporate taxation according to the incidence
of the burden is that a Justification for the sales factor
1 0Ratliff, Interstate Apportionment of Business
Income for State Income Tax Purposes, p. 8 7.
135
is provided. This is hardly sufficient to make the idea
worthwhile.
A major reason, noted earlier, for abandoning the
premise that the corporate net income tax is not shifted
is that the theory depended on the doctrine of pure pro
fit. Pure profit is a residual, the difference between
payments to other factors of production (land, labor,
capital) and total revenue. Functionally, it is the
reward to the entrepreneur for his enterprise, for taking
the risks, for coordinating and planning.11 Corporate
net income taxes are not levied on pure profit but on
business (or accounting) profit, for it is the higher of
the two. Business profit is the difference between in
come and explicit costs, and includes pure profit,
monopoly profit, and implicit costs. The geographical
determination of the sources of business profit, for pur
poses of levying an income tax, is a hopeless taskj too
many dynamic forces are responsible for profits. So we
have another strike against such a business tax.
Since the corporate net income tax is a fact, some
method of apportionment of interstate corporate income
must be settled upon. An attack that yields a formula
that is both practically and theoretically sound can be
^H. H. Liebhafsy, The Nature of Price Theory,
(Homewood, Illinois: The Dorsey Press, Inc., 1 9 6 3), pp.
24—29j 383-386.
136
devised in the light of the fact that businessmen tend
to treat corporate income taxes as expenses, pricing
12
their product after having accounted for such taxes.
For a firm to continue operating in the long run, income
must be sufficient to cover all costs. Income is the
equivalent of output. The key to this approach to the
division of income for tax purposes is this: what
produces income? Economic theory teaches that factors
of production do so. A Justifiable formula should be
possible by apportioning income among states according
to the location of these factors.
It is at this point that sales-factor advocates
insist that there would be no realization of income with
out sales, and utility theory has been summoned up in
13
support. This aspect has not been very widely discussed
in relationship to the particular problem of apportionment
hut it apparently rests on the notion that a commodity's
value arises from both production expenditures and con
sumer utility, and an apportionment formula without a
sales factor neglects the importance of the latter. There
is no doubt that utility is an important element in the
determination of economic value, through the part it plays
12
Due, Government Finance, pp. 216-217.
^Jerome R. Hellerstein, "Allocation and Nexus in
State Taxation of Interstate Business," Tax Law Review,
XX (January, 1 9 6 5), p. 275.
137
in consumer demand and therefore prices. But expenditure
is the other side of the income coin. An apportionment
formula that accounts for all property and all payroll
of a corporation thereby accounts for the total value of
the corporation's production. The market price of a
commodity reflects the value added to it by each step of
production up to and including its actual sale. A pay
roll property apportionment formula would account for
all the income created, for the total value of the good,
by including all the value expended in producing it.
The next problem is locating the factors of pro
duction responsible for the income. The basis for doing
so would logically be the firm's expenditurs. The for
mula would be simple; expenses incurred in a state would
be compared with total expenditures and that proportion
of income would be apportioned in the state. This is
appealing from a theoretical standpoint, but it has many
practical weaknesses. Expense location could be mani
pulated, compliance and administrative costs would be
increased by the necessity of additional state-by-state
records, expenditures like advertising would be difficult
to attribute, and— a critical consideration--it would be
a radical departure from present practices. With little
effort, however, this expense formula can be converted
138
14
into a practical, familiar form. Payrolls represent
the amounts spent on labor, and property values indicate
the value of the services of land and capital. These are
both easily located, and nearly all the income tax
states already incorporate both in their apportionment
formulae (see Table 3-^)*
An objection might be raised to the effect that
it is not acceptable to add together in the same formula
property, which is a stock, and payroll, a flow; but the
use of property and payroll factors with each weighted
according to its importance in the production process
would yield a fair indication of production locale. The
weighting raises several problems. It is difficult to
measure the contribution of each factor to output,
especially for some types of business. Moreover, although
different weights for either different industries or
fimms would be more precise, the resultant complexities
15
in tax law would be too great a price to pay. Exped
iency again wins over precision; the usual practice, and
it will apparently be continued, is for the factors to
be equally weighted.
A theoretical approach leads to the conclusion
^Ratliff, Interstate Apportionment of Business
Income for State Income Tax Purposes, p. § T l
-^Morss, A Study of How Corporate Income Should Be
Apportioned for Taxation by States, p. 108.
139
that3 with respect to dividing corporate income for
state tax purposes, the apportionment formula which has
the most to recommend it is one "based on property and
payroll factors. It has satisfactory theoretical support;
it is also relatively simple, certain, easy to comply
with and to administer.
Economic Effects
Location decisions. Unlike the corporate income
tax at the federal level, the state corporate income tax
is not generally considered to have significant impact
upon investment decisions. As demonstrated in Tahle 3-5*
the state net income tax rates on corporations— especially
in comparison to federal rates--are very low. It is
possible that this tax has some influence on businessmen’s
decisions concerning location of economic activity, but
that influence is apparently minor. Certainly corpora
tion officials are interested in the "tax climate" of a
state before undertaking operations there, but this
covers such considerations as how taxes are administered,
-^John P. Due, "Studies of State-Local Tax
Influences on Location of Industry," National Tax Journal,
XIV, No. 2 (June, 1 9 6 1), pp. 163-173; Charles E.
Ratliff, Jr., "Interstate Apportionment of Business
Income," National Tax Journal, XV, No. 3 (September,
1 9 6 2), pp. 2 6 0, 2 6 4.
not just the types and rates of various levies.1^ A
number of other inducements will, individually or col
lectively, carry at least as much weight as tax factors.
Some of these (just which will depend on the nature of
the business) are the quality of public services, regional
growth, transportation costs, political climate, weather,
utility rates, labor costs, and--if the company is
dependent upon attracting employees from other areas—
such items as the housing situation and intellectual
atmosphere.1® Nevertheless, to the extent that companies
manipulate their business activities in order to take
advantage of differences in regulations, the corporation
income tax imposed by state governments interferes with
the free flow of commerce within the nation. The bulk
of the blame for this type of misallocation of resources
rests on the diversity that exists among the states in
the methods of taxing the incomes of multistate businesses.
Nonuniformity is a burden on the economy as a whole,
operating to depress per capita real income. Uniformity
would tend to neutralize the effect of the state corporate
income tax on business decisions.
Revenue impact. Another economic effect
■^William J. Shultz and C. Lowell Harriss, American
Public Finance, (Englewood Cliffs, N. J.: Prentice-Hall.
Inc., 1 9 6 3), p. 335-
l8Ibid., p. 334.
l4l
involving the state corporate income tax is its revenue
impact. When collections from this tax are compared to
total state tax collections, they may seem of relatively
less importance than other revenue sources (see Table
3-6). But they are of great concern to individual states,
each of which faces expanding demands upon its services.
Each tax administrator believes his state's apportionment
formula best for obtaining revenue. It is this concern
on the part of the state tax officials that has made
revision of the interstate taxation situation problem
atical. With improved administration of taxes under a
uniform system and especially in areas of industrial
growth (i.e., an expanding tax base), revenue considera
tions need not be a prime factor in uniformity proposals.
At the very least, it can be said that this is one of
many considerations, each equally or more important.
Several recent studies have concluded that tax revenues
of individual states would not be substantially different
whether an apportionment formula contained a sales factor
based on destination, a sales factor based on origin, or
no sales factor at all. Revenue is not the important
19
issue in the initiation of a uniform formula.
19H. R. 1480, pp. 529-563, A157-A195, A477-A509;
Elliott R. Morss, "Apportioning Corporate Income Among
States for Tax Purposes," Taxes, XLII, Wo. 4 (April,
1964), pp. 2 6 1-2 6 6.
142
Compliance and, collection costs. There are two
additional effects of the corporation income tax at the
state level that should be mentioned. These are not
defects inherent in the tax itself, but problems that have
developed because state laws and regulations are not
uniform. An additional burden is imposed on the economy
because more resources are allocated to tax compliance
and administration than would be the case with uniform
methods of levying and assessing taxes. Divergent rules
and interpretations lead to poor compliance. State
authorities have an understandable tendency to permit
variations from legal requirements where liability appears
small. In time the frequency of auditing income-
dividing taxpayers, even those whose records are located
out-of-state, may be brought to satisfactory levels. For
the present, state income tax administration is plagued
with major deficiencies in available funds, numbers and
training of personnel, and in the intensity of auditing
20
and verification activitives.
There is much disagreement over the relationship
between compliance costs and state corporate income
taxes. One point of view is that such costs are
20Clara Penniman and Walter W. Heller, State Income
Tax Administra.tion, (Chicago: Public Administration
Service, 19590a P- 259*
143
excessive for multistate corporations; taxpayers face
higher record-keeping, accounting, and legal costs than
21
would be the case under a uniform system. Another is
that compliance costs are not burdensome at present, but
would be if tax laws were properly observed and enforced.
2 2 still a third, usually that of tax administrators, is
that compliance costs are no more costly to interstate
corporations, relative to tax liability and gross income,
than they are to intrastate firms.2^ A reasonable con
clusion to be drawn from this disagreement is that com
pliance in itself is a significant problem. Uniformity
might not solve it, but it would be a great step in the
right direction. Where compliance costs were excessive,
21
Albert H. Cohen, Apportionment and Allocation
Formulae and Factors Used by States in t evying Taxes
Based on or Measured by Net Income of ManufacturingT
Distributive and Extractive Corporations, (New York:
Controllership Foundation, 1954), p. 44; an estimate based
on replies to questionnaires from nearly 800 firms showed
that compliance costs would be reduced on the average by
nearly 3 3# if a uniform apportionment formula were adopted.
See also Fred J. Mueller, Burden of Tax Compliance Keeps
Mounting for Small Business Firms, ’1 Journal of Taxation,
XXI, No. 6 (December, 1964), pp. 3 7 8-3 8 5.
2 2H. R. 1480, pp. 334, 334.
23ciarence W. Lock, "A Moderate's Viewpoint on
State Taxation of Interstate Commerce," The Tax Executive,
XVII. No. 4 (July, 1 9 6 5), p. 321; Robert L. Roland, ’
’ ’ Public Law 86-272: Regulation of Raid?" Virginia Law
Review, XLVI, No. 6 (October, i9 6 0), p. 1186.
144
uniformity would mitigate the situation to some degree.
The remaining controversy is over what uniform plan will
best do the job.
Equity
In the literature of taxation, a tax meets the
criterion of equity if the distribution of the burden of
the tax conforms with the pattern of income distribution
regarded as the optimum by the consensus of opinion in
contemporary society. Determination of equity must rest
on value judgments; but two general approaches to the
problem have dominated thinking and policy-making in the
field. One is the principle of ability to pay; the other,
benefits received.
Ability to pay. The ability to pay justification
for business taxation states that business enterprise,
like individuals, should contribute to the government its
share based on its faculty or ability to pay taxes. It
maintains that the business entity exists and functions as
an economic entity which possesses an ability to pay taxes
separate from that of the owners. There is no consensus,
however, as to whether this principle can be applied to
corporate income taxation. One view holds that this
concept relates to burdens borne by individuals, not
corporations. Individual income may be a reasonable
145
24
equity index, but corporate income is not. The busi
ness entity does not possess an independent ability to
25
pay. Things do not pay taxes; persons do. ^ There is no
reason to tax income earned through the corporate form
more (or less) heavily than that earned in other ways.
Given different profit levels, different amounts of
capital invested, and different degrees of risk involved
in various businesses, how can ability be measured? It
is more logical to levy taxes directly on persons than
indirectly through businesses. This approach requires
close integration of the corporate and personal income
taxes.
The alternate approach is the treatment of the
corporation as a separate entity for tax purposes, with
26
its net income a suitable base for taxation. The
corporation is distinct from its owners; stockholders
typically have no direct control over policies. In the
United States, tax treatment of corporate income has been
2^John F. Due, Government Finance, 3rd ed.
(Homewood, Illinois: Richard D. Irwin, Inc., 19&3)* p.
103.
^Elliott R. Morss, "An Evaluation of the Report on
State Taxation," National Tax Journal, XVTII, No. 3
(September, 19&5)* P* 300.
iURichard A. Musgrave, The Theory of Public Finance,
(New York: McGraw-Hill Book Company, Inc., 1959)* p. 173*
146
27
based predominantly on this philosophy. * It should be
added that a prime reason for the corporate income tax
oft
is that of social expediency. The corporation is a
convenient source of income and is therefore taxed. In
addition, such a tax prevents the use of the corporation
as an instrument for avoiding the personal income tax.
This is a far more satisfactory approach to justification
of the corporate income tax than is reliance on the
ability principle. Expediency, not justice, is the
2Q
essential rationale. ^
The benefit principle. This theory comes from
the marketplace, and states that goods should be paid
for by the users. To meet the equity criterion, a tax
must be passed on to persons in the same way as the
benefits (services) received. A taxpayer’s burden must
be proportional to his share of total tax-financed
ftO
benefits from the service. This is the states' most
oft-proclaimed basis for corporate income taxation; the
state provides certain benefits, such as protection, and
^Gerhard Colm, "The Corporation and the Corpora
tion income Tax in the American Economy," American Econ
omic Review, XLIV, No. 2 (May, 1954), pp. 486-501'.
2®Due, Government Finance, p. 212.
29william h. Anderson, Taxation and the American
Economy, (New York: Prentice-Hall, Inc., 1951)* P• 600.
3°Shultz and Harriss, o£. cit., p. 332.
147
is therefore entitled to a tax. The corporate net
income tax suffers when Judged by the benefit criterion,
however, for some familiar reasons. Government services
benefit persons, not firms. A business is a conduit for
benefits. Direct taxes on persons for most government
services do not provide a practicable alternative. It
would be difficult for states to tax stockholders outside
the state for benefits to their corporation within the
state.Rather than follow the diffusion of benefits
on an individual basis, it is more expedient to deal with
the collective benefit, before diffusion occurs, by
taxing the earnings of business e n t e r p r i s e s.^3 in con
nection with corporate income taxes, the concept of ex
pediency occurs frequently. Before the turn of the cen
tury, Adolf Wagner pointed out that the entry of govern
ments into the welfare field precluded any general use of
^4
the benefit principle. The measurement of the costs of
^Elliott R. Morss, A Study of How Corporate Income
Should be Apportioned for Taxation by States, unpublished
Ph.D. "dissertation, Johns Hopkins University, 1 9 o 3 s p. 28.
32Paul J. Hartman, "State Taxation of Corporate
Income from a Multistate Business," Vanderbilt Law Review,
(December, 1959)> P* 26.
^Morss, A Study of How Corporate Income Should Be
Apportioned for Taxation by States, pp. 28-30.
3^Paul Studenski, "Toward a Theory of Business Taxa
tion, " Journal of Political Economy, XLVIII (October, 1940)
p. 629.
148
government services— privileges to society— or of the
value of them to the corporation is extremely difficult.
Even if these tasks were accomplished* it is unlikely
that such amounts would he proportional to net income and
35
hence suitably paid for by the corporate income tax.
The benefit principle would be better satisfied by user
changes* fees* specific business taxes, or a value-added
tax. The gasoline tax which supplies highway funds is
our best example of a good benefits-received tax situa
tion. If the tax base is determined by where production
occurs, a fair approximation of the value-added tax is
achieved by the use of a two-factor (property, payroll)
apportionment formula.
Taxation on the basis of benefits received will
not guarantee optimum resource allocation, but on ef
ficiency grounds it is probably as good a general finance
criterion for state governments to try to approximate
as there is. At least the beneficiary is aware that
government goods and services are not costless. But
problems arise when the principle is applied to interstate
corporations. For example, assume that two corporations
are earning the same incomej one operates entirely in
35Adolf Wagner, Finanzwissenschaft, Part I, 3rd ed.,
Leipzig, 1883, pp. 4-l6, reprinted in Classics in the
Theory of Public Finance, edited by Richard A. Musgrave
and Alan T. Peacock, (London: Macmillan & Co., Ltd.),
1958.
State A and the other is interstate. Both get the same
amount of benefits from State A. What percentage other
states tax is irrelevant to what State A should doj namely
choose combinations of rate and base so that each firm
has the same tax liability. This is not to indicate that
uniformity is unimportant. Reduction in legal violations
is itself a valid enough argument, among others, in favor
of uniform tax rules and enforcement. But insurance
that no corporation pays taxes on more than 100# of its
income may not be a valid argument. The fact remains
that there is a nearly universal belief in the principle
that no business should be required to pay taxes on an
37
amount in excess of its actual net income.
The corporate net income tax satisfies neither
the ability principle nor the benefit principle. Other
criticisms of the tax are particularly relevant at the
state level. It is not the responsibility of states to
insure full employment, and so the fluctuating nature of
the base is a liability. The tax Is also undesirable to
36a.. R. Prest, Public Finance in Theory and Prac
tice, (Chicago: Quadrangle Books, 1 96O), p. 3 2 9. For an
analysis of state governments1 expenditures and distribu
tion of benefits to business, see Elliott R. Morss, A
Study of How Corporate Income Should be Apportioned For
Taxation by States, unpublished dissertation, Johns
Hopkins University, 1 9 6 3.
37jjorss, "An Evaluation of the Report on State Taxa
tion," o | ) . cit., p. 3 0 1.
150
the extent that it permits states to determine how income
nQ
should be distributed among the states. State taxation
of* corporate income is nevertheless an established prac
tice. There is little likelihood of its abandonment.
The view held by many economists has been well summed up
by James Buchanan.
. . . Few arguments on either economic or ethical
grounds can be advanced in its favor. The tax
is grossly unfair as to the distribution of
burden among persons, and its economic effects,
while unpredictable in large part, can scarcely
be consistent with equity, efficiency, or growth
objectives.39
Some Alternative Multilevel Fiscal Arrangements
This study treats the present state tax system as
given, and its aim is to deal, with currently pending
proposals. This brief digression into alternate fiscal
relationships is included in the hope that wider reforms
of the system will eventually come about.
There has been a great deal written in recent
years about modification in present tax practices, mostly
in the direction of more extensive tax coordination
3®Arthur B. Barber, "State Taxation of Net Income
Derived from Interstate Commerce," American Bar Associa-
tion Journal, XLVIII (December, 1 9 6 2 7, p. 1134; fc. R.
1460, Ch. 123 Lock, o£. cit., p. 328.
^Morss, "An Evaluation of the Report on State
Taxation, " oj>. cit., p. 3 0 3.
151
between various levels of government As state and
local revenue needs grow beyond the magnitudes that the
lower levels of government can or will handle--and they
are bound to do so— wise tax coordination with the
4l
federal government becomes essential. Whatever the
form* the purpose is to assist the lower levels of
government.
Separation of Revenue Services
Separation of revenue sources is one of the
suggested methods; implementation would involve repeal
of some federal taxes. The primary difficulty with the
idea is that there is absolutely no agreement about
which taxes should be repealed. The uneven distribution
of taxpaying potential makes it highly unlikely that
additional state revenue would accrue where it was most
needed. Moreover, some revenue sources are useful to
lower governments only if used by the federal government
also; most of these involve high administrative costs
^°See James A. Maxwell, Financing State and Local
Government, the Brookings Institution, Washington, D.C.,
l9S5Tals5- Harold M. Groves, "Centralized Versus Decen
tralized Finance," Federal Expenditure Policies for Econ
omic Growth and Stability, Joint Economic Committee,
Congress of the tJnited States, Washington, D.C.: United
States Government Printing Office, November 5* 1957, pp.
188-194.
4l
See Dick Netzer, "Financial Needs and Resources
Over the Next Decade: State and Local Governments," Na
tional Bureau of Economic Research, Public Finances:
Needs, Sources and Utilization, 1961, pp. 23-77.
152
Ilo
relative to their yield. Also, federal tax reduction
would have no effect on state and local revenues (except
indirectly, as it resulted in higher levels of national
income) unless specific steps were taken. If those ad
ditional steps involved replacing the federal taxes with
state and local ones, the consequences would "be undesir
able. Increases would probably be largely in sales
taxes at the state level and property taxes at the local
level, both of which are regressive a l r e a d y .^3 Assuming
state measures would be voluntary, response would pro
bably be spotty, failing to channel revenue in larger
shares to poorer states. Lower governments have diffi
culty moving into vacated tax areas because of public
opposition to higher taxes and official fear of inter
state competition for revenue sources between states and
localities.
4*2"Federal-State-Local Government Fiscal Relations"
The Federal Tax System: Facts and Problems, 1964,
Joint' Economic Committee, Congress of the United States,
Washington, D.C.: United States Government Printing
Office, 1964, pp. 193-194.
Joseph A. Pechman, "Financing State and Local
Government," The American Bankers Association, Proceedings
of a Symposium on Federal Taxation, Washington, D. C.,
jferch 26, 19b5, New Yorki The American Bankers Associa
tion, p. 7 8.
44
Ibid., p. 79-
153
Tax Sharing and Tax Supplements
Tax sharing is another method of federal tax;
coordination; the central government would collect* then
share* a portion of revenues. The distribution would be
to states and their subdivisions. This practice is not
uncommon at the state-local level. The main problem in
using the technique at the federal level is that tax
rates vary; any one rate would hurt some states and help
others. Richer states would benefit relatively if the
redistribution of a tax were based on source of collec-
4 5
tion* rather than on need. Another federal collection
plan would have the central government collect all taxes
and then remit the proper amount to various states. Each
state would impose its own taxes at its own rates. The
taxpayer would file one return with results of all trans
actions allocated or apportioned according to some uni
form rule. Since a gingle agency (perhaps the Internal
Revenue Service) would collect* audit* and remit funds*
there would be put a single forum for enforcements*
46
settlement of disputes* and initiation of remedies.
This plan has a powerful detractor which applies to an
^"Pederal-State-Local Government Fiscal Rela
tions*" Joint Economic Committee* p. 194.
^Donald K. Barnes* "Prerequisites of a Federal
Statute Regulating State Taxation of Interstate Commerce*"
Virginia Law Review* XLVI* No. 6 (October* i9 6 0)* p. 1273.
154
extent to most of these programs: state governments are
jealous of "states' rights," It is not likely they
would ever relinquish so much power to the federal govern
ment .
Close cousins to the last two plans are those
involving tax supplements. A tax would he assessed as a
percentage of the federal tax; the federal form could
include state taxes, computed as a percentage of federal
levies. Collection and enforcement, as before, would
come from the central government. This integration of
taxing units would promote progressivity in the tax bur
den, but it would make lower governments susceptible to
changes in federal provisions. Of particular relevance
to this study Is the observation that tax supplements of
47
this sort are too complex for interstate firms.
The deductibility of some state and local taxes
on the federal tax return is one type of tax coordination
now in use.' It promotes uniformity of the tax burden
among different areas and lightens the state tax burden
because the amount of taxes paid is not as great as the
actual amount of the tax. All methods of tax coordina
tion are made more complex, and sometimes rendered
^"Federal-State-Local Government Fiscal Rela
tions," Joint Economic Committee, pp. 196-197.
^8Ibid., p. 195.
155
unworkable* by variations in taxing practices among the
states.
Grants-in-Aid and Tax Credits
Although grants-in-aid are not strictly a type
of tax coordination, they should be mentioned because
their purposes are similar to many tax reform schemes.
They promote national uniformity in minimum standards of
service, and are usually conditional upon matching or
related state or local expenditure. One of their advan
tages is that they allow the federal government to regu
late the conditions of the spending. They redistribute
wealth and income, since federal aid is financed by
taxes primarily from wealthy states and benefits go
primarily to less fortunate areas. Some claim that this
saps taxpayer initiative and makes for dependency upon
the central government. It can be effectively argued
that a high degree of economic interdependence makes
redistribution desirable; and grants may stimulate fiscal
Alq
initiative by state and local governments. ^ More
general grant systems have been suggested to help with
problems that cannot be appropriately dealt with by
specific g r a n t s . Recent proposals of unconditional
^9ibid., p. 1 9 9-
^Pechraan, o£. cit., p. 8 0.
grants, distributed to the states on such bases as
51
population, have received much attention. They would
not, however, stimulate any fiscal reform on the part of
the states, or serve to redistribute income in a desir
able way, or contribute to stability. A superior plan
5 2
using tax credits has been devised. Taxpayers would
be allowed to offset all or part of their payments of
specified state taxes in computing federal tax liability.
The states would still control their respective tax
systems, but individual taxpayers would get rebates.
These "instant tax credits" would stimulate states' tax
efforts and would promote uniformity. They would redis
tribute income (to the extent that state and local taxes
are regressive on the whole), relieve the tax burden on
homeowners, and lighten the job load of state tax offi
cials .
Such tax credits would not automatically increase
state revenues' governmental units which already impose
taxes eligible for credit would have to increase rates.
States without income taxes would benefit by the full
5^-Walter ¥. Heller, "The Future of Our Fiscal
System," Journal of Business, (July, 1 9 6 5)* PP* 235-244:
and Pechman, op. cit., pp. 71-84 and "Discussion," pp. 85-
108.
-^Harold M. Somers, "The Heller Plan, A Critique
and an Alternative," Institute of Government and Public
Affairs, University of California, Los Angeles, November,
1965, PP. 16-32.
157
amount of the credit* if they imposed such a tax. In
many cases state constitutions prohibit income taxes.
An additional criticism is that a system of tax credits
in itself would not serve to redistribute revenue to
53
needier states. It is important to note* in connection
with that criticism* that credits would neutralize the
5 A
burden of state and local taxes on the poor.
This section has included only a small sampling
of proposals being developed around more closely inte
grated state and federal fiscal relationships. Because
our ecnnomy’s need for efficient coordination is steadily
increasing* it is important that we explore all their
possibilities.
^Pechman* o£. cit.* p. 7 9*
5^-Somers, "The Heller Plan* A Critique and an
Alternative* 1 1 pp. 28-30.
CHAPTER VI
THE FUTURE OF STATE CORPORATE INCOME TAX UNIFORMITY
In the near future some broad changes in the
system of state corporate income taxation will take place.
They may or may not have significant impact on multistate
corporations. This chapter reviews the pros and cons of
federal legislation in connection with the state net
income tax on business. Before stating a conclusion on
this question* the Alternatives to federal legislation
are scrutinized. The last step before a final summariza
tion and recommendation is an evaluation of the particular
federal proposal now pending.
The Question of Congressional Action
The legislation now before Congress— the Inter
state Taxation Act--is a direct result of the work of the
Special Subcommittee on State Taxation of Interstate
Commerce. The Subcommittee's report* not including the
records of hearings* fills four volumes; the portion of
158
159
the report devoted to net income taxes is H. R. 1480.
A good deal of the conflict as to the advisability of
federal legislation in the area of taxes on interstate
companies refers directly to the work of the Subcommittee.
Opposition to Federal Legislation and Criticism of the
Subcommittee on State taxation of Interstate Commerce
Objections to interference by the central govern
ment and criticisms of H. R. 1480 have been many and
vigorous. They have come most frequently from state tax
administrators who have found fault with both the method
ology and conclusions of the Subcommittee. Many believe
that H. R. 1480 fails to present the states' arguments
adequately^ and that the Subcommittee, in effect, knew
2
what results it wanted before it began its work.
Several complaints are most frequently voiced.
1) The Subcommittee’s report implies that one
set of r*ules can cover every possible situation in
questions of tax liability for interstate firms. Tax
administrators believe that many problems fall in a
^~State Taxation of Interstate Commerce, H. R.
1480, Report of the Special Subcommittee on State Taxa
tion of Interstate Commerce of the Committee on.the
Judiciary, House of Representatives, 8 8th Cong., 2nd Sess.
Volumes 1 and 2, June 15? 1964] hereinafter referred to
ad H. R. 1480.
p
Clarence W. Lock, "A ModerateSs Viewpoint on
State Taxation of Interstate Commerce," The Tax Execu
tive, XVII, No. 4 (July, 1965), P. 323*
i6o
"grey area;" solutions require negotiation. Answers
must be both practical and reasonable, and cannot be
anticipated by a fixed set of regulations.^ This is
related to the belief in a lack of Congressional compet
ence to deal with state and local problems; a federal
administrative body cannot be as flexible and responsive
2l
as is necessary to such problems.
2) There is danger that interstate firms will be
given some degree of competitive advantage at the price
of fairness to intrastate businesses.^
3) If Congress can set jurisdictional standards
for state taxes and in effect prohibit a state tax on
net income from interstate commerce--as it did in P. L.
8 6 -2 7 2 when taxation of sellers with no business location
was barred--then it can prohibit all state taxes. The
fact that Congress can void an otherwise constitutional
state tax is destructive of the federal concept of
government.^
4) The reasons for Congressional intervention
^Ibid.
William D. Dexter, "THe Case Against Federal
Intervention," State and Local Taxes on Business, sympos
ium conducted by the Tax Institute of America, October
28-30, 1964, Princeton: Tax Institute of America, 1 9 6 5,
p. 102.
^Lock, o£. cit., p. 324.
6Ibid., p. 326.
l6l
are not adequately established; there is still no satis
factory statistical basis for proceeding to federal law
at this time.^ For example, the Subcommittee's informa
tion on noncompliance ^ d nonenforcement is based
largely on 1 9 5 9 data; this was a year of confusion for
both corporations and tax officials because of the
Q
Northwestern-Stockham decision. Revenue effects of
different apportionment formulae were minimized by
measuring dollar impact against total state tax revenues,
q
instead of against the particular tax revenue involved.
Both compliance and revenue studies suffered from
weaknesses in the statistical process. The size of the
compliance cost sample was too small; the revenue results
were based on too many unwarrented assumptions and gaps
in the data. 10
5) There is no assurance that a federal statute
would bring certainty to corporate taxpayers or less
litigation to the courts. The number of court cases
involving the Internal Revenue Service demonstrates that
7Jerome R. Hellerstein, "Allocation and Nexus
in State Taxation of Interstate Business," State and
Local Taxes on Business, symposium conducted by the Tax
Institute of America, October 28-30, 1964, Princeton:
Tax Institute of America, 1965, pp. 74, 84.
Q
Lock, o£. cit., p. 321.
9Ibid., p. 3 2 5.
lc>Hellerstein, o|) . cit., pp. 74-90.
162
many taxpayers challenge their liabilities or the regu
ll
lations, even under a law that is nationally uniform.
Support for H. R. 1480 and Congressional Action
Those favorably disposed toward the Subcommittee's
conclusions and recommendations tend to concur in feeling
that the opposition bases its stand on certain "myths:"
that interstate companies are mostly corporate giants;
that the present system works well, at least for the
states; that uniformity will cause grievous revenue con
sequences for states; that elimination of a sales factor
gives some competition advantage to out-of-state com
panies; that states will take effective action to remedy
12
present ills on their own. Several points are made in
advocacy of action by Congress.
1) The constitutional aspects of the controversy
are omitted completely by the fact that the power to
regulate commerce among the states had been in federal
hands since the drawing of the Constitution. The current
11Mitchell Wendell, remarks in "Montreal Debate on
Congressional Limitation of State Taxation of Interstate
Commerce," Bulletin of the Section of Taxation, American
Bar Association, XX, No. 2 (January, 1 9 6 7), p. 152.
■^Murray Drabkin, "The Role of Myth in State
Taxation of Interstate Business-, " State and Local Taxes
on Business, symposium conducted by the Tax Institute of
America, October 2 8-3 0, 1964, Princeton: Tax Institute
of America, 1965> PP* 55-64.
question, then, is not one of federal intervention
versus states' rights; hut rather, the status quo of
litigations (primarily decisions of the Supreme Court)
versus legislation (with rules laid down by C o n g r es s ) . * 1 ^
In spite of the fact that the Court's attitude over the
years has shifted from emphasis on exemption of inter
state business from taxation to permissiveness toward
state tax practices, one clear note has been sounded in
all decisions and opinions of members of the Court, both
affirming and dissenting: the ultimate power to regulate
fctate taxation of interstate commerce is a Congressional
14
prerogative. The litigation process has nevertheless
persisted because of what has been called the "blowG
torch” principle; only the badly burned waht something
done; those who have not been will delay proposals of
solutions while dealing with problems on a day-to-day,
16
ad hoc basis. The point here is not that a federal law
concerning state taxation of interstate corporate income
would drastically reduce the number of disputes that are
litigated. It is rather that the courts are not geared
■**3jess N. Rosenberg, remarks in ’ ’ Montreal Debate
on Congressional Limitation of State Taxation of Inter
state Commerce," Bulletin of the Section of Taxation,
American Bar Association, XX, No. 2 (January, 1967)* p.
152.
l2*Ibid., p. 1 5 3-
x5ibid., p. 156.
164
to proclamations of general principles or insurance of
organized sets of rules in tax matters. Their rulings
are of necessity on a case-by-case basis and their
decisions are narrow in scope. Taxpayers should not
have to rely on this approach to tax policy formation.
2) The major arguments for federal legislation
are the adverse effects of the present system. For
example, sales are assigned to various states by six
general standards, used singly or in combination. Com
pounding the difficulty are at least half a dozen
variations of what constitutes destination, and about
16
three variations of origin. The existence of this
state of affairs is a disadvantage to small firms in
particular, and has undesirable effects on the economy as
a whole. The latter reflect the inhibition of the free
flow of commerce resulting from competitive disadvantage
imposed on a firm paying taxes on more than 1 0 0# of its
income, or paying excessive taxes in any given state; and
from the economic waste caused by excessive compliance
costs. The system can of course be harmful to intra
state businesses when there is undertaxation of foreign
-^Franklih c. Latcham, remarks in "Montreal
Debate on Congressional Limitation of State Taxation of
Interstate Commerce," Bulletin of the Section of Taxa
tion, American Bar Association, XX, No. 2 (January,
1967), p. 15b.
165
f i r m s .^ This can result from uncoordinated taxing
practices of states in combination with the extensive
possibilities for noncompliance arising from uncertainty
of liability. Even though the Subcommittee's study was
unable to substantiate the existence of excessive com
pliance costs, there is no doubt that noncompliance is
rampant, and that enforcement of regulations is spotty.
The equity of a tax system depends to some extent on
consistent enforcement. Uneve laxity is unfair,
The Question of Collective Action by the States
The Multistate Tax Compact is the states1 answer
to the proposed federal legislation. Opposition to any
further action in this area by the central government is
the principal reason for the Compact's popularity. Every
reason advanced against Congressional legislation is a
point made in favor of the Compact. Its advocates point
out that the states have given evidence that they can
effectively solve the uniformity problem; eleven state
legislatures have already accepted the Compact and bills
18
to do so are pending in at least five other states.
^Arthur B. Barber, remarks in "Montreal Debate on
Congressional Limitation of State Taxation of Interstate
Commerce," Bulletin of the Section of Taxation, American
Bar Association, XX, No. 2 (January, l9ffi)» "P* 162.
l8State Tax Review, XXVIII, No. 29 (July 6, 1967),
p. 3.
Opposition to a Multistate Agreement
Those who favor a federal law seriously doubt
the effectiveness of state action, based on the long
history of states' apathy toward previous plans for
uniformity. Certain factors mitigate against the
success of a multistate agreement; the individual states’
power to tax is a jealously guarded thing. Moreover,
every state is subject to varying degrees of pressure
20
from instate business interests. The Compact concept
has serious practical drawbacks. To solve the problems
of the present system, such a compact would have to be
approved by all the income tax states and by Congress.
Since no state could delegate legislative power to the
new governmental entity administering the compact, each
substantive change would have to be ratified by all the
state legislatures. This process could take years. 21
Specific Criticisms of the Provisions of the Multistate
Tax. Compact
Jurisdiction. The Compact does not specify
■^See Charles E. Ratliff, Rr., Interstate Appor
tionment of Business Income for State Income Tax Pur-
poses*] (Chapel Hill: University of North Carolina Press,
W & J , pp. 1 7-2 1.
2^Stephen C. Nemeth, Jr., remarks in "Montreal
Debate on Congressional. Limitation of State Taxation of
Interstate Commerce," Bulletin of the Section of Taxation
American Bar Association, XX, No. 2 (January, 1967)* p.
on
Barber, o£. cit., p. 163.
i6T
jurisdictional limitations. The portions explaining
the three-factor apportionment formula* as well as several
other provisions* indicate that either sales alone or a
business location constitute sufficient nexus for taxing.
This leaves the jurisdictional standard up to the indi
vidual states. Although it is possible that the provi
sions of the Compact would encourage uniformity in
regulations on taxable nexus, it would simplify the sys
tem to establish specifically uniform jurisdictional
limitations. The simultaneous solution of jurisdiction
and apportionment is considered by some to be a superior
method* with distinct rules neither necessary nor
22
desirable. The division of income rules in this compact
however* are optional* as discussed below.
Division of Income. A three-factor (property,
payroll* sales) formula is employed* with specific allo
cation of named items; but any taxpayer in any party
state may allocate and apportion according to the Compact
or according to the laws of the party state. Either
procedure can beuused in all or any one or more party
states in any given year. The onjfcy element of uniformity
that this provides over the present system is the fact
that each party state would have to allow use of a three-
22James A. Maxwell* Financing State and Local
Government, The Brookings Institution, Washington* D.C.,
1965* P. 112.
factor apportionment formula if the taxpayer so desired,
with sales attributed by destination. This is not much
of an improvement. The requirement in each party state
of a short form for filing, available to companies that
only sell in a state and whose gross volume is not in
excess of $1 0 0,0 0 0, would simplify compliance procedures
for very small firms.
Definition of Income. Early in 1966 the National
Association of Tax Administrators suggested that tax
reform include adoption by states of the federal income
23
tax base, subject to adjustments. Unfortunately, the
Multistate Tax Compact makes no mention of definition of
taxable income in relation to the Internal Revenue Code.
Out-of-state audits. The National Association of
Tax Administrators also recommended that the practice of
having the taxpayer bear the costs of out-of-state audits
24
be altogether eliminated. The Compact specifies that
the Multistate Tax Commission would never charge a tax
payer for an audit; but the Commission would perform
audits at its own discretion. The taxpayer is sure of
protection from charges only in states that already make
'it a practice to bear such costs, or when the Commission
^Loek, op. cit., p. 3 2 6.
pk l f
^Joseph P. Stapchinskas, Hearings Begin on Re
form of Interstate Taxation; States Fight Willis Bill,V
Journal of Taxation, XXIV, No. 3 (March, 1 9 6 6), p. 1 7 8.
agreed to perform the audit.
Admini s t rat ion. States argue that Congressional
legislation would be evidence of expanding federal en
croachment and growing bureaucracy; but the Compact ne
cessitates the creation of more government in the form
of the Multistate Tax Commission. An entire additional
level of administration is established.
Conclusion. A multistate agreement would have to
be universally accepted to be effective. If past behav
ior can be taken as any indication, the states are
unlikely to agree in totoj and subsequent modifications,
necessitating approval by all, would be really problem
atical. The single greatest criticism of the Compact is
that it accomplishes so little toward insuring real
uniformity. The significant problems in state taxation
of interstate firms have to do with jurisdictional
limitations and division of income among states. This
Compact would guarantee that any multistate taxpayer can
use specific allocation and the three-factor formula as
defined in the provisions, or the individual state's
formula. It is apparently assumed that this would
encourage every income tax state to use the specified
formula. Even if this were the case, the adjustment
process would take some time. In the meantime, the
taxpayer could not be sure of uniform regulations except
by using the three-factor formula suggested. This might
170
not, in every state in which there was a choice, be to
his advantage. To make that determination, the tax
liability under both sets of rules would have to be
computed. The diversity of formulae, as well as the many
standards for attributing sales, are left untouched.
The attitude is that the corporation can have uniformity
or can continue to use apportionment practices already
in effect. The Compact is designed to put minimal re
strictions on state powers; it succeeds there, but
misses the realization of uniformity in the process.
The Debate Over the Interstate Taxation Act
Advocatesoof H. R. 2158, the Interstate Taxation
Act, look predominately to the line of reasoning pre
sented under "Support for H. R. 1480 and Congressional
Action" to demonstrate the merits of the federal bill.
State tax officials have expressed several specific
objections to it.
Jurisdiction
The opposition claims that the bill's jurisdic
tional provisions would allow for more tax avoidance by
using subsidiary corporations, independent contractors,
and any methods that would bypass ownership or leasing of
property, employees based in the state, or maintenance of
171
inventory.2- * Any statutory jurisdictional standard
would create broad areas of exemption, and H. R. 2158
is without specific reference to exemptions. A statutory
standard at this time could give rise to at least as
many problems of interpretation as now exist. Exemption
26
provisions should be left to individual states. Some
tax administrators claim that the bill does little more
than place certain types of transactions and taxpayers
beyond the jurisdictional, reach of one or more states or
municipalities.2^
Division of Income
The Subcommittee recommends the two-factor (pro
perty, payroll) apportionment formula allegedly because
of its simplicity5 but large manufacturers are supporting
H. R. 2158 because such a formula would reduce their tax
liabilities. The Subcommittee consistently expressed
concern for the small corporations. The Federal Small
25john J. O’Connell, remarks in "montreal Debate
on Congressional Limitation of State Taxation of Inter-
State Commerce," Bulletin of the Section of Taxation,
American Bar Association, XX, No. 2 (January, 19b?), p.
J7BT.
2(%heodore W. DeLooze, remarks in "Montreal Debate
on Congressional Limitation of State Taxation of Inter
state Commerce," Bulletin of the Section of Taxation,
American Bar Association, XX, No. 2 (January, 1$67), p.
TPT.
2^Wendell, loc. cit.
172
Business Administration defines a small business as one
with less than $1,000,000 gross income, and less than
200 employees. H. R. 2158, however, covers corporations
with net income of $1,000,000 or less. For wholesaling
and retailing businesses with net incomes of that amount
the average rate of return is around 2% of s&les^ such a
company could have $50,000,000 gross sales. For indus
trial businesses, the average rate of. return is higher,
around 5# or 6$. Such a company could still have
$20,000,000 in sales. This would seem to substantiate,
in part, the criticism that the proposed Act would be
28
highly beneficial to larger corporations.
On the other hand, the legislation does not re
quire uniformity in dividing income among the states.
State and local governments are free to utilize nearly
all the nonuniform provisions they please, even though
compliance costs could be increased. The bill does not,
it is argued, require or encourage uniformity, ostensibly
29
its major purpose.
Definition of Income
H. R. 2158 makes specific reference to the
Internal Revenue Code of 195^ as being the one used to
28q 'Connell, loc. cit.
2^Wendell, loc. cit.
173
compute a company's annual income to determine whether
or not the corporation is covered by the provisions of
the bill. There is no mention of amendments to the Code,
which are many. It would be better to refer to taxable
income as determined for purposes of the federal return,
with adjustments specified or left to the states. The
tax base to which the apportionment fraction is applied
is the corporation's taxable income as determined under
state law. It is true that more states are tending to
use the federal base as a starting place in computing
state liability, but another chance for uniformity was
passed up here.
Conclusions
The sales factor controversy has been explored
at length. The conclusion reached was that the two-fac
tor apportionment formula is sound, theoretically and
practically] reasonably certain; commendably simple; and
not likely to be problematical with respect to compliance
or administration. The two-factor formula in the pro
posed legis'. ,cion, however, is optional. It sets outer
limits to the taxpayer's liability, which in most cases
must still be computed more than one way to determine the
more favorable treatment.
The limitation of the provisions to corporations
with net incomes of not more than $1,000,000 likewise
174
waters down the effectiveness of the bill with respect
to uniformity. This is a measure designed to relieve
the problems of small businesses^ but many of those
covered are not really small. It is true that state
audits are much more likely for the larger firms* so
those excluded from coverage are probably the more
closely-watched in their compliance practices. On the
other hand* they have been provided with no relief from
the possibilities of under- or overtaxation* and with no
guarantee of costless out-of-state audits.
As for definition of income* the current taxable
income for federal purposes should have been specified as
a uniform starting point for state tax computations.
As was the case with the Multistate Tax Compact*
the proposed legislation provides uniformity for those
who want it. It may tend to bring states closer to
uniform practices, but it doesn't accomplish this itself.
If a Jurisdictional standard is to be specified for all
the states* then it is logical to require a uniform
apportionment formula as well.
The Implementation of Uniformity
Alternatives
Multistate agreement. Even if every income tax
state agreed to comply with the Multistate Tax Compact,
the effect on interstate corporations would not be signi-
175
fleant. The Compact would not ensure uniformity. For
example* by using the specified three-factor apportion
ment formula in every state in which taxes are owed*
the corporation could reduce compliance problems and
dangers of duplicative taxation. The corporation might
also be paying more taxes than would be the ease if the
different apportionment formulae available in various
states were employed. There is* in addition* no uni
formity prescribed for the tax base.
H. R. 2158» the Interstate Taxation Act. The
bill now before Congress would be more effective in
promoting uniformity than the Multistate Tax Compact
because outside limits to the corporation's liability
are prescribed. It is also the better plan because the
two-factor formula is preferable. However, it does not
cover the taxpayers who are most significant in terras of
revenue. It does not guarantee uniformity because the
two-factor formula is optional. As in the case of the
Multistate Tax Compact, tax base determination is left
to the states.
Other methods of Congressional Implementation of
uniformity. It is conceivable that Congress could bring
about uniformity in other ways; e.g.* by suggesting an
apportionment formula and then instituting a credit
against the federal corporation income tax for state
income taxes (up to some maximum) paid to states using
176
the approved formula. This plan might include use of
the federal definition of taxable income and possibly—
not necessarily— some type of central administration.
The major criticism here is that states whieh do not levy
SO
income taxes on corporations would be forced to do so.
Or, if the suggested formula were not adopted, Congress
could disallow the deduction from the federal tax base
of state corporation income taxes paid. This would not
discriminate against non-income taxes paid. This would
penalize states which did not follow Congress’ suggestion.
Plans like these seem unnecessarily indirect in accom
plishing the desired goal of uniformity.
Recommendations
Neither of the two current proposals would accom
plish their stated purpose, namely, the establishment of
uniform practices for taxes on interstate corporations.
The federal legislation ranks higher by this criterion
than does the Multistate Tax Compact; the same comment
applies to the theoretical bases for both.
Legislation of this nature from the central
government could insure conformity. The interests of the
national community should take precedence over the
narrower interests of some states. Taxpayers have a
30Ratliff, op. cit., p. 105.
177
right to expect regulations which are equitable* certain*
and reasonably simple. Competition for industry and
trade among the states should be in the efficiency of the
services provided by the states for their tax dollars*
rather than in the amount of such tax dollars.
Congressional stipulation of uniform jurisdic
tional standards* apportionment formula* and tax base
definition appears to be the most pragmatic path to
uniformity in state taxation of interstate corporation's
net income. The necessary legislation should allow for
specific allocation; the apportionment of total income
by statutory formula* as is the case in H. R. 2158*
presents legal and theoretical difficulties with respect
to nonunitary income of a business. The apportionment
formula provided should be based on two factors* property
and payroll. Such a formula will have various effects
on particular states* depending on the predominant
nature of the state’s output (i.e.* how industrialized
the state is). But any uniform formula would affect
diffferahtly the revenues of individual states.
A uniform method for determining the tax base
should be established* specifying current federal taxable
income as a starting point* after which states could make
adjustments (e.g.* whether or not federal taxes would be
deductible).
CHAPTER VII
SUMMARY AND CONCLUSIONS
Summary
The Problem
Since 1911 when Wisconsin initiated the first
effective state income tax, 38 other states (including
the District of Columbia) have enacted similar laws.'*'
As the national economy has grown, so has the volume of
business carried on across state lines. Corporations
whose operations carry them into more than one state have
faced the increasingly difficult problem of dealing with
a number of sets of tax regulations. The negative as
pects of the nonuniformity among state laws are numerous.
Compliance is very poor, partly because of a generally
low standard of enforcement by states. The problems of
tax administrators are overwhelming; their facilities and
staffs are not expanding as rapidly as the demands upon
them. Since individual states have different methods of
178
■kAs of January 1, 1 9 6 8, Michigan will be the
40th income tax state (State Tax Review, XXVIII, No. 29
July 6, 1 9 6 7* P* !•)•
179
computing a corporation's tax bill* the possibility of
either over- or undertaxation exists. A firm may be
required to pay taxes on more than or far less than
1 0 0# of its net income.
The diversity gives rise to another undesirable
practice, that of states1 competing f i b r trade and in
dustry on the basis, to some extent, of tax considera
tions. The lack of uniformity in state corporation tax
laws is unfair to taxpayers— inter- and intrastate— and
not in the best interests of the economy as a whole.
Limits to State Powers
The sources of limitations on state taxing
powers are three: the United States Constitution, the
judiciary, and Congress. The due process clauses and
the commerce clause of the Constitution are the only
ones relative to business activity across state lines;
both are very broad. The judiciary has so far borne
most of the burden of general interstate business tax
decisions. The procedure is unsatisfactory because a
court— even the Supreme Court— rules on a case-by-case
basis. This is not the proper arena for policy-making
where an organized set of rules is needed. In 1959 the
Supreme Court handed down a decision, in the
Northwestern-Stockham cases, that set into motion forces
demanding clarification of the interstate tax system.
l8o
The limits of a state's jurisdiction to tax a corporation--
what constitutes taxable nexus-~was called into question.
The business community raised an outcry, and as a result
P. L. 86-272 was passed by Congress.
This is the only Congressional legislation in the
area of state taxation of interstate commerce. Its
effect was to rule out the possibility of taxation of
corporations whose only activity in a state is soliciting
orders, approved and filled outside the state. Tax
administrators objected to this law as an unconstitutional
raid upon state powers, but no court has substantiated
their opinion.
Jurisdiction and Apportionment
Besides the question of jurisdiction to tax, the
division of income of interstate corporations among states
for tax purposes has been a tremendous problem. The con
troversy of jurisdiction has to do with what makes a cor
poration taxable by a state government. Division of income
refers to how a corporation will apportion its net income
among those states which can assert tax liability. The
jurisdictional argument has settled into two main camps,
differing over whether or not a company which only sells
in a state should be taxable by that state.
The division of income question is even more hotly
contended. Several methods are used to divide income.
l8l
The most popular one, and therefore the signifleant item
of the controversy, is apportionment formula. This in
volves computing a percentage of income attributable to a
state on the basis of certain factors, e.g., property and
payroll. The fractions of each relative to the company's
total respective values for each are computed, added to
gether, and divided by the number of factors. This yields
the fraction that will be multiplied by the total income
of the corporation to attribute a portion to the state.
The argument over apportionment formulae centers on what
factors should be included; specifically, sales. Property
and payroll are generally agreed upon.
Diversity in State Regulations
The problems examined here exist because of the
incredible diversity in state regulations with respect to
taxation of corporations. Jurisdictional rules are numer
ous and often uncertain. Taxable income--the tax base--
is not defined the same way in each state. Apportionment
formulae vary. Even when the factors are the same, dif
ferences persist. Sales are attributed by at least half
a dozen different standards. There are other factors in
use in some states. Some allow separate accounting—
treating each state's business operations as if they were
a unit; most do not. Many require specific allocation of
nonunitary items (assignment of income not directly connect
182
ed with regular business operations to the state where
it arises), tout there is disagreement on just what should
be allocated, and how.
Current Proposals
P. L. 86-272 made provisions for a Congressional
study of state taxation of interstate commerce; one
result of that study is H. R. 2 1 5 8, the Interstate
Taxation Act now before Congress. It provides for the
two-factor (property, payroll) apportionment formula as
an outside limit on a corporation's taxable liability in
any given state, and would require a business location
before tax liability could be asserted. It is limited,
however, to firms with taxable annual income not in
excess of $1,0 0 0,0 0 0.
In response to the threat of federal legislation,
the states have proposed a Multistate Tax Compact, A
three-factor (property, payroll, sales) formula is
included, but is optional for corporations (states must
allow it). Firms may still use the individual state's
regulation if desired. Sales activity would be taxable.
A Multistate Tax Commission is created to administer the
Compact.
The Theory of Corporate Income Taxation and Apportionment
Before coming to any conclusions about the
relative merits of the current proposals, a look at the
corporation income tax itself is warranted. An analysis
of shifting and incidence indicates that at least a por
tion of the burden of the tax: is borne by persons other
than owners of the business, but exactly how much and by
whom is impossible to determine. Construction of an
apportionment formula on the basis of burden of the tax
is not feasible. The same comment applies to a tax
apportioned according to the geographical sources of
business profit. As close an approximation as possible
to a theoretically justifiable formula is one based on the
location of the factors of production. This conclusion
comes from the belief that it is these factors which
create income (output). The advocates of the sales factor
argue that income is realized only when the sale is made,
and therefore the market deserves recognition. However,
the value of the factors of production, represented by
property and payroll, accounts for all selling activity.
Economic effects. The economic effects of cor
porate taxation at the state level reinforce the advis
ability of the two-factor formula. It would simplify
compliance and collection problems, both because of uni
formity and because of elimination of any type of sales
factor. It would minimize state competition for business
through tax factors and contribute to a more efficient
allocation of resources throughout the economy.
Possibilities for over- and undertaxation would be
184
removed. Opponents argue that excessive compliance costs
are a paper tiger. Even if this were so, there is no
question that noncompliance is a great problem, and
uniformity in regulations would mitigate it. States are
very fearful of the revenue impact of formula change.
Any uniform apportionment formula.will have different
effects on individual states. The benefits, however,
far outweigh the costs. In no case would those effects
be dangerously large.
Equity considerations. The state corporate in
come tax must be judged also on the basis of its equity,
which i3 determined by how closely to current social
standards the burden of the tax is distributed. An anal
ysis incorporating first the ability-to-pay principle and
next the benefits-received principle has given rise to
the conclusion that the corporation income tax itself has
no basis in equity considerations. The corporation is a
convenient source of revenue, and this is the reason for
the tax. Corporate net income is not an index of ability
to pay, for it is only persons who possess this. It is
misleading to entertain the idea that no persons are
bearing the burden of the state tax. As for the benefit
principle, net income is no indication of state services
received. Again, people, not business units, receive
benefits. There is no reliable way to measure either the
value of the benefits dispersed by the state, or the
185
portions of those benefits conferred upon any group.
The state corporation income tax does not make a
decent showing when judged by either of these basic
principles. Since it is a fact, however, a satisfactory
apportionment formula must be devised. The extent of a
corporation's presence within a state may be measured by
the expenditures of the company in that state. Expense
location can be manipulated; something like separate
accounting would be necessary; and apportionment on this
basis would be too great a departure from present prac
tices. The idea can be implemented, however, by converting
the expenditures into the value of the factors of produc
tion. Payrolls are kept for purposes of unemployment
compensation records, and real property is reasonably
easily located and valued.
Multilevel Fiscal Relations
With hopeful thoughts toward the future, a brief
section on alternative multilev&l fiscal arrangements has
been included. Prom a theoretical point of view, there is
much to recommend elimination of the corporate income tax
altogether, at least at the state level, with perhaps a
system of grants put into effect to avoid revenue loss by
the^ states. It is highly unlikely that states would
relinquish so much taxing power; and in the light of that
fact, tax credits hold much promise for helping alleviate
186
the pinch on state revenues within the framework of the
existing tax structure. A tax credit plan would allow
taxpayers to offset all or part of their state taxes in
computing federal tax liability.
Conclusions
When a tax system depends upon voluntary compli
ance for its success, it is essential that tax liability
be certain; relatively easily determined, complied with,
and enforced; and equitably distributed. By these stan
dards, state taxation of corporation net income is a
travesty of sizable proportions. The remedy is uniformity
in tax practices. The primary conclusion drawn from the
present study is this: the central problem to be solved
is lack of uniformity in state tax practices with respect
to taxation of corporate income.
The Multistate Tax Compact
The Multistate Tax Compact is rejected as an
effective solution to nonuniformity. The apportionment
formula specified in the Compact is optional; firms must
know their liabilities under this formula and the one in
use in any given state to determine which is advantageous.
This promises no degree of uniformity. Moreover, the
formula specified in the Compact is based on property,
payroll, and sales. The sales factor is not a valid basis
for apportionment of income for many reasons.
187
1) There is no theoretical justification for
including sales among the factors creating income (output).
Property and payroll account for the productive efforts of
men and materials devoted to selling] a sales factor gives
extra weight to the resources used in effecting sales.
2) The sales factor is the chief source of com
pliance difficulties for corporations. The nature of
the business operations of some companies precludes the
possibility of maintaining sales records. For many others,
it is a very difficult and expensive process.
3) The sales factor makes audits difficult for
state tax agencies. They cannot hope to check through
records of innumerable sales invoices.
4) Elimination of the sales factor would not have
any more of a disruptive effect on state tax practices
than would imposition of any one type of sales factor
formula.
5) Elimination of the sales factor would not have
dangerously harmful revenue effects on any state.
The Multistate Tax Compact fails to specify any
uniform definition of the tax base, which has been another
source of compliance difficulties for corporations.
The jurisdiction standard indicated in the Compact
would allow states to tax companies whose only instate
activities were selling. The arguments against this are
those against the use of the sales factor.
188
Finally* the Multistate Tax Compact is not a work
able solution to nonuniformity* because any subsequent
changes would have to be approved by each party state.
This would be extremely slow and highly uncertain. The
Compact would* of course* have to be adopted by every
income tax state in the beginning* to qualify as any
solution at all. The states1 record of cooperation on
interstate tax uniformity plans is consistently poor.
Even if they all enacted this Compact* uniformity in
important areas of state tax practices would still not be
realized.
The Interstate Taxation Act
The jurisdictional standard of a business location
set out in the Interstate Taxation Act is a good one;
unfortunately* the effect is weakened considerably by the
limitation of the coverage of the bill to companies
earning no more than $1*000*000. Although it is true that
interstate tax problems weigh heavier on the smaller
companies* it seems an abandonment of principle to
advocate uniformity in tax regulations as they apply to
some taxpayers* and not to others.
The criticism of the Multistate Tax Compact with
respect to definition of tax base applies to this proposal*
too; the determination of taxable income for apportionment
purposes is left to the states.
189
Another weakness in the federal bill is that it
does not allow for specific (direct) allocation. It is
logical to allocate certain items of non-business income
(e.g., rents) to the location at which they arise, for
taxation there.
A final criticism of the Interstate Taxation Act
is that the apportionment formula is made optional.
Corporate taxpayers must know their tax liabilities under
this formula and that of each taxing state before being
able to make a wise choice between the formulae. The
two-factor formula is clear, relatively easy to apply,
and within the enforcement abilities of tax officials.
It is theoretically sound as well.
The Interstate Taxation Act would not guarantee
uniformity in state income tax practices. It falls far
short of its goal. However, if the only choice is between
implementation of the Multistate Tax Compact and this
federal bill, the latter is a greater step in a far better
direction.
Federal Action Recommended
Uniformity in state corporate income tax regula
tions is a matter of consequence to the individual states;
but it is also of concern to businessmen operating across
state lines and to consumers throughout the states and
nation. Federal legislation is not only appropriate; it
190
is the only certain path to uniformity. There is no doubt
that noncompliance with the state corporation income tax
is common* and that enforcement of regulations is poor.
Compliance costs are burdensome* especially for small
firms* and economically wasteful. Collection of the taxes
is not as effective and is more expensive than it ought to
be. Duplicative taxation can put the interstate corpora
tion at a competitive disadvantage to the intrastate firm;
undertaxation is also possible* which reverses the roles.
Such a diverse tax system cannot possibly be neutral in
its effects on business activity.
The existing system* requiring recourse to the
judiciary in case of disputes or where rules are unclear*
is highly unsatisfactory. This is not a proper source for
a system of ground rules for taxation. Historically* the
states have demonstrated repeatedly that they are incapable
of agreeing upon and implementing a solution themselves.
Now that rather extensive federal legislation is a real
possibility* they have rallied behind the Multistate Tax
Compact with a greater degree of cohesiveness than usual.
Eleven have enacted the Compact; six other legislatures
are considering bills to do so. This is still less than
half of the income tax states* although acceptance by
seven (and the approval of Congress) would make the
Compact effective. This Compact would not achieve uniform
ity in tax practices* even if all 39 states enacted it.
191
The major areas which should be made uniform
through federal legislation are as follows.
Definition of income. Whenever computation of a
state's tax base does not begin with the federal defini
tion of taxable income, the taxpayer is responsible for
mastery of two bodies of law. This is one basis for non-
compliance with state income tax regulations. It would
not cause significant harm to any state if the federal tax
base were to be specified as the starting point for state
corporate income tax figures, and the benefits to corpora
tions would be considerable. Many states, in practice,
alreasy use the Internal Revenue Code as the basis for
their definitions of taxable income. The.first specific
recommendation, then, is that the termination of the tax
base be made uniform, and based upon the current federal
definition of taxable income.
Jurisdiction. State jurisdiction to tax interstate
corporations should be limited to those with an instate
business location, as defined in the Interstate Taxation
Act. This prohibits taxation of companies whose only
business activity in a state is selling, with orders
approved and filled from outside the state. This makes
tax liability more easily determinable, both for the tax
payer and the tax administrator. It also is in line with
theoretical considerations which attribute income creation
to the property and payroll factors, already accounted for
192
in the apportionment formula.
Division of income. The two-factor (property,
payroll) formula is recommended as being clear and
relatively simple to determine, which is to the benefit
of both taxpayers and tax officials. It is the one appor
tionment formula that would, when imposed, cause the
least total disruption in state tax practices. Most of
the states use these factors and define them very much the
same way. The addition of any uniform third factor would
cause adjustments by most of the states, since there is
so much variation in types, definitions, and combinations
of factors beyond property and payroll.
On theoretical grounds, the property and payroll
formula is the best available approximation of taxation
of a company according to there income is created. These
two items account for the corporation's expenditures on
productive factors, whether they be devoted to research or
to selling. The third specific recommendation is the
adoption of the two-factor apportionment formula.
Conclusion
Two proposals now pending, the Multistate Tax
Compact and the Interstate Taxation Act, claim to offer
solutions for the problems of nonuniformity in state
corporate tax practices. Of the two, the federal
legislation has more to recommend it. However, although
193
federal legislation is the only way to achieve real
uniformity, another bill should be drawn up. It is
recommended that it incorporate the elements of uniformity
outlined above: determination of taxable income according
to the current federal definition; jurisdiction limitations
to corporations with instate business locations; and
apportionment of income using a two-factor (property,
payroll) formula. It is further recommended that such a
bill be made applicable to all interstate corporations,
regardless of size (amount of taxable income).
Uniformity in state taxation of interstate com
panies is an important and worthwhile goal. Whatever
modifications occur in the tax system in the long run, a
tremendous improvement can be affected now by enactment of
federal legislation implementing uniformity in a few
major areas.
I
APPENDIX
195
PUBLIC LAW 86-272
Title I.
Section 101. Imposition of net income tax.
(a) Minimum standards.
No state, or political subdivision
thereof, shall have power to impose, for any
taxable year ending after September 14, 1959>
a net income tax on the income derived within
such state by any person from interstate com
merce if the only business activities within
such state by or on behalf of such person
during such taxable year are either, or both,
of the following:
1. The solicitation of orders by such
person, or his representative, in such state
for sales of tangible personal property, which
orders are sent outside the state for approval
or rejection, and, if approved, are filled by
shipment or delivery from a point outside the
statej and
2 . the solicitation of orders by such
person, or his representative, in such state
in the name of or for the benefit of a pros
pective customer of such person, if orders by
such customer to such person to enable such
customer to fill orders reulting from such
solicitation are orders described in paragraph
1 .
(b) Domestic corporations; persons domiciled in
or residents of a state.
The provisions of subsection (a) of this
section shall not apply to the imposition of a
net income tax by any state, or political
subdivision thereof, with respect to
(1) Any corporation which is incorporated
under the laws of Such state; or
(2) Any individual who, under the laws
of such state, is domiciled in, or a resident
of, such state,
196
(c) Sales or solicitation of orders for sales
by independent contractors.
For purposes of subsection (a) of this
section, a person shall not be considered to
have engaged in business activities within a
state during any taxable year merely by reason
of sales in such state, or the solicitation of
orders for sales in such state, of tangible
personal property on behalf of such persons by
one or more independent contractors, or by
reason of the maintenance of an office in such
state by one or more independent contractors
whose activities on behalf of such person in
such state consist solely of making sales, or
soliciting orders for sales, of tangible person
al property.
(d) Definitions.
For purposes of this section--
(1) The term "independent contractor"
means a commission agent, broker, or other
independent contractor who is engaged in selling,
or soliciting orders for the sale of, tangible
personal property for more than one principal
and who holds himself out as such in the regular
course of his business activities; and
(2) The term "representative" does not
include an independent contractor.
Section 102. Assessment of net income taxes;
limitations; collection.
(a) No state, or political subdivision thereof,
shall have power to assess, after September 14,
1 9 5 9> any net income tax which was imposed by
such state or political subdivision, as the case
may be, for any taxable year ending on or before
such date, on the income derived within such
state by any person from interstate commerce, if
the imposition of such tax for a taxable year
ending after such date is prohibited by section
101 of this title.
(b) The provisions of subsection (a) of this
section shall not be construed—
(l) To invalidate the collection, on or
197
September 14, 1959> of any net income tax
imposed for a taxable year ending on or before
such date, or
(2) To prohibit the collection, after
September 14, 1959 > of any set income tax which
was assessed on or before such date for a
taxable year ending on or before such date.
Section 103* Definition.
For purposes of this chapter, the term "net
income tax" means any tax imposed on, or
measured by net income.
Section 104. Separability provision.
If any provision of this chapter or the appli
cation of such provision to any person or
circumstance is held invalid, the remainder of
this chapter or the application of such pro
vision to persons or circumstances other than
those to which it is held invalid, shall not be
affected thereby.
Title II.
Section 201.
The committee on the judiciary of the House of
Representatives and the committee on finance of
the United States Senate, acting separately or
jointly, or both, or any duly authorized sub
committee thereof, shall make full and complete
studies of all matter pertaining to the taxation
of interstate commerce by the state, territories,
and possession of the United States, the
District of Columbia, and the Commonwealth of
Puerto Rico, or any political or taxing sub
division of the foregoing.
Section 202.
The committees shall report to their respective
Houses the results of such studies, together
with their proposals for legislation on or
before June 30, 1 9 6 5.
198
UNIFORM DIVISION OF INCOME FOR TAX PURPOSES ACT
Definitions. 1. As used in this Act, unless the
context otherwise requires:
(a) "Business Income" means income arising from
transactions and activity in the regular course of the
taxpayer's trade or business and includes income from
tangible and intangible property if the acquisition, mana
gement, and disposition of the property constitute inte
gral parts of the taxpayer's regular trade or business
operations.
(b) "Commercial domicile" means the principal
place from which the trade or business of the taxpayer is
directed or managed.
(c) Compensation" means wages, salaries,
commissions and any other form of remuneration paid to
employees for personal services.
(d) "Financial organization" means any bank,
trust company, savings bank, industrial bank, land bank,
safe deposit company, private banker, savings and loan
association, credit union, cooperative bank, investment
company, or any type of insurance company.
(e) "Non-business income" means all income
other than business income.
(f) "Public utility" means (any business en
tity which owns or operates for public use any plant,
equipment, property, franchise, or license for the trans
mission of communications, transportation of goods or per
sons, or the production, storage transmission, sale,
delivery, or furnishing of electrivity, water, steam, oil,
oil products or gas).
(g) "sales" means all gross receipts of the
taxpayer not allocated under sections 4 through 8 of this
act.
(h) "State" means any state of the United
States, District of Columbia, the Commonwealth of Puerto
Rico, any territory or possession of the United States, and
any foreign country or political subdivision thereof.
Who must allocate and apportion - exceptions. 2.
Any taxpayer having income from business activity which is
taxable both within and without his state, other than
activity as a financial organization or public utility or
the rendering of purely personal services by an individual,
shall allocate and apportion his net income as provided in
this Act.
Taxpayers taxed in another state. 3. For purposes
199
of allocation and apportionment of income under this Act*
a taxpayer is taxable in another state if ( 1) in that
State he is subject to a net income tax, a franchise tax
measured by net income, a franchise tax for the privilege
of doing business, or a corporate stock tax, or (2) that
state has Jurisdiction to subject the taxpayer to a net
income tax regardless of whether, in fact, the state does
or does not.
Allocation of non-business income. 4. Rents and
royalties from real or tangible personal property, capital
gains, interest, dividends, or patent or copyright
royalties, to the extent that they constitute non-business
income, shall be allocated as provided in sections 5
through 8 of this Act.
Allocation of rents and royalties. 5. Net rents
and royalties from real property locatedin this state
are allocable to this state, (b) net rents and royalties
from tangible personal property are allocable to this
state:
( 1) if and to the extent that the property is utilized
in this state, or
(2) in their entirety if the taxpayer's commercial
dimicile is in this state and the taxpayer is not organ
ized under the laws of or taxable in the state in which
the property is utilized.
(c) The extent of utilization of tangible personal pro
perty in a state is determined by multiplying the rents
and royalties by a fraction, the numerator of which is the
number of days of physical location of the property in the
state during the rental or royalty period in the taxable
year and the denominator of which is the number of days
of physical location of the property everywhere during all
rental or royalty periods in the taxable year. If the
physical location of the property during the rental or
royalty period is unknown or unascertainable by the tax
payer tangible personal property is utilizedin the state
in which the property was located at the time the rental
or royalty payer obtained possession.
Allocation of capital gains and losses. 6. (a)
Capital gains and losses from sales of real property
located in this state are allocable to this state. (b)
Capital gains and losses from sales of tangible personal
property are allocable to this state if
(1) the property had a situs in this state at the time
of the sale or
(2) the taxpayer's commercial domicile is in this state
if the taxpayer's commercial domicile is not taxable in
the state in which the property had a situs, (c) Capital
200
gains and losses from sales of intangible personal property;/
are allocable to this state if the taxpayer's commercial
domicile is in this state.
Allocation of interest and dividends. 7* Interest
and dividends are allocable to this state if the tax
payer's commercial domicile is in this state.
Allocation of patent and copyright royalties. 8.
(a) Patent and copyright royalties are allocable to this
state:
(1) if and to the extent that the patent or copyright
is utilized by the payer in this state, or
( 2) if and to the extent that the patent or copyright
is utilized by the payer in a state in which the taxpayer
is not taxable and the taxpayer's commercial domicile is
in this state. (b) A patent is utilized in a state to
the extent that it is employed in production, fabrication,
manufacturing or other processing in the state or to the
extent that a patented product is produced in the state.
If the basis of receipts from patent royalties does not
permit allocation to states or if the accounting pro
cedures do not reflect states of utilization, the patent
is utilized in the state in which the taxpayer's commer
cial domicile is located.(c) A copyright is utilized in a
state to the extent that printing or other publication
originates in the state. If the basis of receipts from
copyright royalties does not permit allocation to states
or if the accounting procedures do not reflect states of
utilization, the copyright is utilized in the state in
which the taxpayer's commercial domicile is located.
Apportionment of business income— percentage. 9»
All business income shall be apportioned to this state by
multiplying the income by a fraction, the numerator of
which is the property factor plus the payroll factor pips
the sales factor, and the denominator of which is three.
Property factor. 10. The property factor is a
fraction, the numerator of which is the average value of
the taxpayer's real and tangible personal property owned
or rented and used in this state during the tax period
and the denominator of which is the average value of all
the taxpayer's real and tangible personal property owned
or rented and used during the tax period.
Property factor— owned and used property. 1 1.
Property owned by the taxpayer is valued at itsoriginal
cost. Property rented by the taxpayer is valued at eight
times the net annual rental rate. Net annual rental rate
is the annual rental rate paid by the taxpayer less any
201
annual rental rate received "by the taxpayer from sub-
rentals.
Property factor— average value. 12. The average
value of property shall be determined by averaging the
values at the beginning and ending of the tax period but
the (tax administrator} may require the averaging of
monthly values during -the tax period if reasonably
required to reflect properly the average value of the
taxpayers property.
Pay-roll factor. 13. The payroll factor is a
fraction, the numerator of which is the total amount paid
in this state during the tax period by the taxpayer for
compensation, and the denominator of which is the total
compensation paid everywhere during the tax period.
Payroll factor--instate. 14. Compensation is
paid in this state if: (a) the individual's service is
performed entirely within the state; or (b) the indivi
dual's service is performed both within and without the
state, but the service performed without the state is
incidental to the individual's service within the state;
or (c) some of the service is performed in the state and
(1) the base of operations, or, if there is no base of
operations, the place from which the service is directed
or controlled is in the state, or ( 2) the base of opera
tions or the place from which the service is directed or
controlled is not in any state in which some part of the
service is performed, but the individual's residence is
in this state.
Sales factor. 15. The sales factor is a fraction,
the numerator of which is the total sales of the taxpayer
in this state during the tax period, and the denominator
of which is the total sales of the taxpayer everywhere
during the tax period.
Sales factor--tangibles sold instate. 16. Sales
of tangible personal property are in this state if: (a)
the property is delivered or shipped to a purchaser, other
than the United States government, within this state re
gardless of the f.o.b. point or other conditions of the
sale; or (b) the property is shipped from an office, store,
warehouse, factory, or other place of storage in this
state and (1) the purchaser is the United States government
or ( 2) the taxpayer is not taxable in the state of the
purchaser.
Sales factor— non-tangible sales. 17. Sales,
other than sales of tangible personal property, are in this
202
state if: (a) the income-producing activity is performed
in this state; or (b) the income-producing activity is
performed both in and outside this state and a greater
proportion of the income-producing activity is performed
in this state than in any other state, based on costs of
performance.
Equitable adjustment of formula. 18. If the
allocation and apportionment provisions of this Act do not
fairly represent the extent of the taxpayer's business
activity in this state, the taxpayer may petition for
or the (tax administrator) may require, in respect to all
or any part of the taxpayer's business activity, if
reasonable: (a) separate accounting; (b) the exclusion
of any one or more of the factors; (c) the inclusion of
one or more additional factors which will fairly represent
the taxpayer's business activity in this state; or (d)
the employment of any other method to effectuate an
equitable allocation and apportionment of the taxpayer's
income.
Purpose of act. 19• This Act shall be so con
strued as to effectuate its general purpose bbomake
uniform the law of those states which enact it.
Citation of act. 20. This Act may be cited as the
Uniform Division of Income for Tax Purposes Act.
203
INTERSTATE TAXATION ACT
(H. R. 2158)
TITLE I--JURISDICTION TO TAX
Sec. 101. Uniform Jurisdictional Standard.
No State or political subdivision thereof shall have
power—
(1) to impose a net income tax or capital stock tax
on a corporation other than an excluded corporation
unless the corporation has a business location in the
State during the taxable yearj
( 2) to require a person to collect a sales or use
tax with respect to a sale of tangible personal pro
perty unless the person has a business location in the
State or regularly makes household deliveries in the
State: or
( 3) to impose a gross receipts tax with respect to
a sale of tangible personal property unless the seller
has a business location in the State.
A State or political subdivision Bhall have power to im
pose a corporate net income tax or capital stock tax, or
a gross receipts tax with respect to a sale of tangible
personal property, or to require seller collection of a
sales or use tax with respect to a sale of tangible
personal property, if it is not denied power to do so un
der the preceding sentence.
TITLE II--MAXIMUM PERCENTAGE OP INCOME OR CAPITAL ATTRI
BUTABLE TO TAXING JURISDICTION
Sec. 201. Optional Two-Factor Formula.
A State or a political subdivision thereof may not
impose on a corporation with a business location in more
than one State, bbher than an excluded corporation, a net
income tax (or capital stock tax) measured by an amount of
net income (or capital) in excess of the amount determined
by multiplying the corporation's base by an apportionment
fraction which is the average of the corporation's pro
perty factor and the corporation's payroll factor for the
State for the taxable year. For this purpose the base to
which the apportionment fraction is applied shall be the
corporation's entire taxable income as determined under
State law for that taxable year (or its entire capital as
determined under State law for the valuation date at or
204
after the close of that taxable year).
Sec. 202. Property Factor.
(a) In General--A corporation's property factor for
any State is a fraction* the numerator of which is the
average value of the corporation's property located in
that State and the denominator of which is the average
value of all of the corporation's property located in any
State.
(b) Property Included--The corporation's property fac
tor shall include all the real and tangible personal pro
perty which Is owned by or leased to the corporation
during the taxable year, except--
(1) property which has been permanently retired from
use, and
(2) tangible personal property rented out by the
corporation to another person for a term of one year or
more.
(c) Exclusion of Personalty from Denominator--The
denominator of the corporation's property factor for all
States and political subdivisions shall not include the
value of any property located in a State in which the
corporation has no business location.
(d) Standards for Valuing Property in Property Factor--
(1) Owned Property--Property owned by the corpora
tion shall be valued at its original cost.
(2) Leased Property--Property leased to the corpora
tion shall be valued at eight times the gross rents
payable by the corporation during the taxable year with
out any deduction for amounts received by the corpora
tion from subrentals.
(e) Averaging of Property Values--The average value of
the corporation's property shall be determined by averaging
values at the beginning and ending of the taxable year.;
except that values shall be averaged on a semi-annual,
quarterly, or monthly basis if reasonably required to re
flect properly the location of the corporation's property
during the taxable year.
Sec. 203. Payroll Factor.
(a) In General-~A corporation's payroll factor for any
State is a fraction, the numerator of which is the amount of
wages paid by the corporation to employees located in that
Statenand the denominator of which is the total amount of
wages paid by the corporation to all employees located in
205
any State.
( I d ) Payroll Included— The corporation's payroll factor
shall include all wages paid by the corporation during the
taxable year to its employees, except that there shall be
excluded from the factor any amount of wages paid to a
retired employee.
(c) Employees not Located in any State--If an employee
is not located in any State, the wages paid to that em
ployee shall not be included in either the numerator or
the denominator of the corporation’s payroll factor for
any State or political subdivision.
(d) Definition of Wages— The term "wages" means wages
as defined for purposes of Federal income tax withholding
in section 3401 (a) of theelnternal Revenue Code of 1954,
biit without regard to paragraph ( 2) thereof.
Sec. 204. Zero Denominators.
If the denominator of either the property factor or the
payroll factor is zero, then the other factor shall be
used as the apportionment fraction for each State and
political subdivision. If the denominators of both the
property factor and the payroll factor are zero, then the
apportionment fraction for the State where the corporation
has its business location shall be 1 00 percent.
TITLE IV--EVALUATION OF STATE: PROGRESS
Sec. 401. Congressional Committees.
The Committee on the Judiciary of the House of Repre
sentatives and the Committee on Finance of the United
States Senate, acting separately or jointly, or both, or
any duly authorized subcommittees thereof, shall for four
years following the enactment of this Act evaluate the
progress which the several States and their political sub
divisions are making in resolving the problems arising
from State taxation of interstate commerce and if, after
four years from the enactment of this Act, the States and
their political subdivisions have not made substantial
progress in resolving any such problem, shall propose such
measures as are determined to be in the national interest.
TITLE V— DEFINITIONS AND MISCELLANEOUS PROVISIONS
Part A--Definitions
Sec. 501. Net Income Tax.
206
A "net income tax" is a tax which is imposed on or
measured by net income, including any tax which is imposed
on or measured by an amount arrived at by deducting from
gross income expenses one or more forms of which are not
specifically and directly related to particular transac
tions .
Sec. 506. Excluded Corporation.
(a) In General--An "excluded corporation" is any
corporation—
( 1) more than 50 percent of the ordinary gross
income of which for the taxable year--
(A) is derived from regularly carrying on
any one or more of the following business activities:
(i) the transportation for hire of pro
perty or passengers, including the rendering by the trans
porter of services incidental to such transportation;
(ii) the furnishing of—
(I) telephone service or public
telegraph service, or
(II) other communications service if
the corporation is substantially engaged in furnishing a
service described in subdivision (I):
(iii) the sale of electrical energy, gas
or water;
(iv) the issuing of insurance or annuity
contracts or reinsurance; or
(v) banking, the lending of money, or
the extending of credit;
(B) is received in the form of one or more
of the following:
i
i) dividends;
ii) interest; or
iii) royalties from patents, copyrights,
trademarks, or other intangible property and mineral, oil,
or gas royalties (but not payments of the type described
in section 543(a) (5) (B) of the Internal Revenue Code of
1954); or
(C) consists of ordinary gross income de
scribed in subparagraph (A) and other ordinary gross in
come described in subparagraph (B);
( 2) which is a "personal holding company" as
defined in section 542 of the Internal Revenue Code of
1954 or a "foreign personal holding company" as defined
in section 552 of such Code; or
(3) which has an average annual income in excess
of $1,0 0 0,0 0 0.
(b) Ordinary Gross Income— The term "ordinary gross
207
income" means gross income as determined for the taxable
year under the applicable provisions of the Internal
Revenue Code of 1954, except that there shall be excluded
therefrom—
(1) all gains and losses from the sale or other
disposition of capital assets, and
(2) all gains and losses from the sale or other
disposition of property of a character described in sec
tion 1231 (b) of the Internal Revenue Code of 1954
(determined without regard to holding period).
(c) Average Annual Income— A corporation's "average
annual income with respect to any taxable year (in this
subsection referred to as the "computation year") shall be
determined as follows:
(1) The period to be used in making the determin
ation (in this subsection referred to as the "averaging
period ) shall first be established. Such period shall
consist of the 5 consecutive taxable years ending with
the close of the computation yearj except that if the
corporation was not required to file a Federal income tax
return for 5 consecutive taxable years ending with the
close of the computation year, its averaging period shall
consist of the 1 or more consecutive taxable years, ending
with the close of that year, for which it was required to
file such a return.
(2) (A) The amount of the corporation's Federal
taxable income for each of the taxable years in its aver
aging period shall then be determined. Such amount for
any year shall be the corporation's taxable income for
such year for purposes of the Internal Revenue Code of
1954 (determined without regard to any net operating loss
carryback from a taxable year after the computation year),
except as otherwise provided in subparagraphs (B) and (C).
(B) If for any portion of its averaging
period the corporation's income was included in a consoli
dated return filed under the Internal Revenue Code of 1954,
the corporation's Federal taxable income for that portion
of such period shall be considered to be the total consoli
dated Federal taxable income included in such return (and
the corporation's Federal taxable income for any portions
of its averaging period to which this subparagraph does
not apply shall be determined under the other provisions
of this paragraph as though the corporation had no Income
for any portion of such period to which this subparagraph
applies).
(O') If any taxable year in the corporation's
averaging period is a period of less than 12 calendar
months (and its taxable income for such year is not other
wise annualized for purposes of the Internal Revenue Code
of 1954), the corporation's Federal Taxable income for
208
such taxable year shall be placed on an annual basis for
purposes of this subsection by multiplying such income by
12 and dividing the result by the number of months in such
year.
(3) The amounts determined under paragraph (2)
for the taxable years in the corporation's averaging per
iod shall be added together* and the total shall be
divided by the number of such years. The resulting sum
is the corporation's average annual income with respect
to the computation year* unless paragraph (4) applies.
(4) (A) If the corporation is affiliated at any
time during the computation year with one or more other
corporations* its average annual income with respect to
the computation year shall be the total of its own average
annual income with respect to the average annual income of
each of the corporations with which it is so affiliated*
as determined under paragraph ( 3) (with respect to such
year) subject to subparagraph (B) of this paragraph.
(B) If two or more of the corporations to
which subparagraph (A) applies with respect to any com
putation year included their income in the same consolidat
ed return filed under the Internal Revenue Code of 1954
for any portion of the applicable averaging period* the
total consolidated Federal taxable income included in such
return shall be deemed to be their aggregate Federal tax
able income for that portion of such period for purposes
of subparagraph (A), and paragraph ( 2) (b) shall be dis
regarded to the extent that its application would result
in a larger aggregate Federal taxable income.
(d) Affiliated Corporations--For purposes of subsec
tion (c)* two or more corporations are "affiliated" if
they are members of the same group comprised of one or
more corporate members connected through stock ownership
with a common owner* which may be either corporate or
noncorporate in the following manner;
(1) more than 5 0 percent of the voting stock of
each member other than the common owner is owned directly
by one or more of the other members; and
( 2) more than 50 percent of the voting stock of
at least one of the members other than the common owner is
owned directly by the common owner.
The fact that a corporation is an "excluded corporation"
sh^lllnot be taken into account in determining whether two
or more other corporations are "affiliated".
Sec. 507. Sale; Sales Price.
The terms "sale" and "sales price" shall be deemed to
include leases and rental payments under leases.
i
209
Sec. 5 0 8. Interstate Sale.
An "interstate sale" is a sale with either its origin
or its destination in a State* but not both in the same
State.
Sec. 509* Origin.
The origin of a sale is--
(1) in the State or political subdivision in which
the seller owns or leases premises at which the property
was last located prior to delivery or shipment of the
property by the seller to the purchaser or to a designee
of the purchaser* or
( 2) if the property was never located at premises
owned or leased by the seller, in the State or political
subdivision in which a business location of the seller is
located and in or from which the sale was chiefly nego
tiated.
Sec. 510. Destination.
The destination of a sale is in the State or political
subdivision where the property is delivered or shipped
to the purchaser* regardless of the f.o.b. point or
other conditions of the sale.
Sec. 511* Business Location.
(a) General Rule--A person shall be considered to have
a business location within a State only if that person--
(1) owns or leases real property within the State*
( 2) has one or more employees located in the
State* or
( 3) regularly maintains a stock of tangible per
sonal property in the State for sale in the ordinary
course of its business.
For the purpose of paragraph ( 3)* property which is on
consignment In the hands of a consignee* and which is
offered for sale by the consignee on his own account*
shall not be considered as stock maintained by the con
signer; and property which is in the hands of a purchaser
under a sale or return arrangement shall not be considered
as stock maintained by the seller.
(b) Exception— If a corporation's only activities
within a State consists of the maintenance of an office
for gathering news the corporation shall not be considered
to have a business location in that State for purposes of
paragraph ( 1) of section 1 0 1* to own or lease real pro
210
perty within that State for purposes of section 202, or to
have an employee located in the State for purposes of
section 2 0 3*
(c) Business Location in Special Cases— If a person
does not own or lease real property within any State or
have an employee located in any State or regularly main
tain a stock of tangible personal property in any State
for sale in the ordinary course of its business (or in
a case described in the last sentence of section 204),
that person shall be considered to have a business loca
tion only—
(1) in the State in which the principal place from
which its trade or business is conducted is located, or
( 2) if the principal place from which its trade
or business is conducted is not located in any State, in
the State of its legal domicile.
Sec. 512. Location of Property.
(a) General Rule--Except as otherwise provided in this
section, property shall be considered to be located in a
State if it is physically present in that State.
(b) Rented-Out Personalty--Personal property which is
rented out by a corporation to another person shall be
considered to be located in a State if the last base of
operations at or from which the property was delivered
to a lesee is in that State. If there is no base of op
erations in any State at which the corporation regularly
maintains property of the same general kind for rental
purposes, such personal propefcty shall not be considered
to be located in any State.
(c) Moving Property which is not Rented Out— Personal
property which is not rented out and which is character
istically moving property, such as motor vehicles, rolling
stock, aircraft, vessels, mobile equipment, and the like,
shall be considered to be located in a State if—
(1) the operation of the property is localized in
that State, or
( 2) the operation of the property is not localized
in any State but the principal base of operations from
which the property is regularly sent out is in that State.
If the operation of the property is not localized in any
State and there is no principal base of operations in any
State from which the property is regularly sent out, the
property shall not be considered to be located in any State.
(d) Meaning of Terms--
211
(1) Localization of* Operation--The operation of
property shall be considered to be localized in a State
if during the taxable year it is operated entirely within
that State, dr it is operated both within and without that
State but the operation without the State is—
(A) occasional, or
(B; incidental to its use in the production,
construction, or maintenance of other property located
within the state, or
(C) incidental to its use in the transpor
tation of property or passengers from points within the
State to other points within the State.
(2) Base of Operations— The term "base of opera
tions", with respect to a corporation's rented-out pro
perty or moving property which is not rented out, means
the premises at which any such property is regularly main
tained by the corporation when--
(A) in the case of rented-out property, it
is not in the possession of a lessee, or
(B) in the case of moving property which is
not rented out, it is not in operation.
regardless of whether such premises are maintained by the
corporation or by some other person; except that if the
premises are maintained by an employee of the corporation
primarily as a dwelling place they shall not be considered
to constitute a base of operations.
Sec. 513- Location of Employee,
(a) General Rule— An employee shall be considered to
be located in a State if--
(1) the employee's service is localized in that
State, or
( 2) the employee's service is not localized in
any State but some of the service is performed in that.
State and the employee's base of operations is in that
State.
(b) Localization of Employee's Service— Service of
any employee shall be considered to be localized in a
State if--
(1) the service is performed entirely within that
State, or
( 2) the service is performed both within and with
out that State, but the service performed without the
State is incidental to service performed within the State.
(c) Employee's Base of Operations— The term "base of
operations , with respect to an employee, means a single
place of business with a permanent location which is
212
maintained by the employer and from which the employee
regularly commences his activities and to which he regu
larly returns in order to perform the functions necessary
to the exercise of his trade or profession.
(d) Continuation of Minimum Jurisdictional Standard—
An employee shall not be considered to be located in a
State if his only business activities within such State
on behalf of his employer are either or both of the
following:
(1) The solicitation of orders, for sales of
tangible personal property, which are sent outside the
State for approval or rejection and (if approved) are
filled by shipment or delivery from a point outside the
State.
(2) The solicitation of orders in the name of or
for the benefit of a prospective customer of his employer,
if orders by such customer to such employer to enable such
customer to fill orders resulting from such solicitation
are orders described in paragraph (1).
This subsection shall not apply with respect to business
activities carried on by one or more employees within a
State if the employer (without regard to those employees)
has a business location in such State.
(e) Employees of Contractors and Extractors--If the
employer is engaged in the performance of a contract for
the construction of improvements on or to real property
in the State or of a contract for the extraction of na
tural resources located in the State, an employee whose
services in the State are related primarily to the per
formance of the contract shall be presumed to be located
in the State. This subsection shall not apply with
respect to services performed in installing or repairing
tangible property which is the subject of interstate sale
by the employer, if such installing or repairing is
incidental to the sale.
(f) The term "employee" has the same meaning as it has
for purposes of Federal income tax withholding under
chapter 24 of the Internal Revenue Code of 1954.
Sec. 515* State.
The term "State" means the several States of the United
States and the District of Columbia.
Sec. 516. State Law.
213
References in this Act to "State Law", "the laws of
the State"* and the like shall be deemed to include a
State constitution* and to include the statutes and other
legislative acts* judicial decisions* and administrative
regulations and rulings of a State and of any political
subdivision.
Sec. 517. Taxable Year.
A corporation's "taxable year" is the calendar year,
fiscal year* or other period upon the basis of which its
taxable income is computed for purposes of the Federal
income tax.
Sec. 5 1 8* Valuation Date.
The "valuation date"* with respect bo a capital stock
tax* is the date as of which capital is measured.
PART B~-Miscellaneous Provisions
Sec. 521. Permissible Franchise Taxes.
The fact that a tax to which this Act applies is im
posed by a State orppolitical subdivision thereof in the
form of a franchise* privilege* or license tax shall not
prevent the imposition of the tax on a person engaged
exclusively in interstate commerce within the State; but
such a tax may be enforced against a person engaged
exclusively in interstate commerce within the State solely
as a revenue measure and not by ouster from the State or
by criminal or other penalty for engaging in commerce
within the State without permission from the State.
Sec. 523. Applicability of Act.
Nothing in section 101 or Lin any other provision of
this Act shall be considered--
(1) to repeal Public Law 86-272 with respect to any
person;
(2) to increase* decrease* or otherwise affect the
power of any State or political subdivision to impose or
assess a net income or capital stock tax with respect to
an excluded corporation; or
(3) to give any State or political subdivision the
power to impose a gross receipts tax with respect to a
sale of tangible personal property if the seller would not
be subject to the imposition of such a gross receipts tax
without regard to the provisions of this Act.
214
Sec. 524. Prohibition Against Out-of-State Audit
Charges.
No charge may be imposed by a State or political sub
division thereof to cover any part of the cost of con
ducting outside that State an audit for a tax to which
this Act applies, including a net income or capital
stock tax imposed on an excluded corporation.
Sec. 525. Liability with Respect to Unassessed Taxes.
(a) Periods Ending Prior to Enactment Date— No State
or political subdivision thereof shall have the power,
after the-date of the enactment of this Act, to assess
against any person for any period ending on or before
such date in or for which that person became' liable for
the tax involved--
(1) a corporate net income tax, capital stock
tax (other than a capital account tax imposed on corpora
tions incorporated in the State), or gross receipts tax
with respect to tangible personal property, if during such
period that person did not have a business location in the
State; or —
(2) a a&les or use tax with respect to tangible
personal property, if during such period that person has
not registered in the State for the purpose of collecting
tax, had no business location in the State, and did not
regularly make household deliveries in the State.
(b) Certain Prior Assessments and Collections— The
provisions of subsection (a) shall not be construed--
(1) to invalidate the collection of a tax prior to
the time assessment became barred under subsection (a), or
(2) to prohibit the collection of a tax at or
after the time assessment became barred under subsection
(a), if the tax was assessed prior to such time.
Sec. 5 2 6. Effective Dates.
(a) Corporate Net Income Taxes and Capital Stock
Taxes--Title II of this Act, and the provisions of section
101 and this title (except section 525) insofar as they
relate to corporate net income taxes or capital stock
taxes, shall apply in the case of corporate net income
taxes only with respect to taxable years ending after the
day of the enactment of this Act, and in the case of
capital stock taxes only with respect to taxes for which
the valuation date is later than the close of the first
taxable year ending after the date of the enactment of
this Act. Any corporation shall be permitted to adjust
its reporting period for net income tax purposes to the
215
to the extent necessary to comply with this Act, effec
tive for the first taxable year to which title XI applies.
(b) Other Provisions--The remaining provisions of this
Act shall take effect on the date of the enactment of
this Act.
216
MULTISTATE TAX COMPACT
Article I. Purposes
The purposes of this compact are to:
1. Facilitate proper determination of State and loaal
tax liability of multistate taxpayers, including the
equitable apportionment of tax bases and settlement of
apportionment disputes.
2. Promote uniformity or compatibility in significant
components of tax systems.
3. Facilitate taxpayer convenience and compliance in the
filing of tax returns and in other phases of tax adminis
tration.
4. Avoid duplicative taxation.
Article II. Definitions
As used in this compact:
1. "State" means a state of the United States, the
District of Columbia, the Commonwealth of Puerto Rico, or
any Territory of Possession of the United States.
2. "Subdivision" means any governmental unit or special
district of a State.
3. "Taxpayer" means any corporation, partnership, firm,
association, governmental unit or agency or person acting
as a business entity in more than one State.
4. "Income tax" means a tax imposed on or measured by net
income including any tax imposed on or measured by an
amount arrived at by deducting expenses from gross income,
one or more forms of which expenses are not specifically
and directly related to particular transactions.
Article III. Elements of Income Tax Laws
Taxpayer Option, State and Local Taxes
1. Any taxpayer subject to an income tax whose income is
subject to apportionment and allocation for tax purposes
pursuant to the laws of a party State or pursuant to the
laws of subdivisions in two or more party States may elect
217
to apportion and allocate his income in the manner pro
vided by the laws of such State or by the laws of such
States and subdivisions without reference to this compact,
or may elect to apportion and allocate in accordance with
Article IV. This election for any tax year may be made
in all party States or subdivisions thereof or in any one
or more of the party States or subdivisions thereof with
out reference to the election made in the others. For
the purposes of this paragraph, taxes imposed by sub
divisions shall be considered separately from State taxes
and the apportionment and allocation also may be applied
to the entire tax base. In no instance wherein Article IV
is employed for all subdivisions of a State may the sum
of all apportionments and allocations to subdivisions
within a State be greater than the apportionment and allo
cation that would be assignable to that State if the
apportionment or allocation were being made with respect
to a State income tax.
Taxpayer Option, Short Form
2. Each party State or any subdivision thereof which
imposes an income tax shall provide by law that any tax
payer required to file a return, whose only activities
within the taxing jurisdiction consist of sales and do not
include owning or renting real estate or tangible personal
property, and whose dollar volume of gross sales made
during the tax year within the State or subdivision, as
the case may be, is not in excess of $100,000 may elect
to report and pay any tax due on the basis of a percentage
of such volume, and shall adopt rates which shall produce
a tax which reasonably approximates the tax otherwise due.
The Multistate Tax Commission, not more than once in five
years, may adjust the $100,000 figure in order to reflect
such changes as may occur in the real value of the dollar,
and such adjusted figure, upon adoption by the Commission,
shall replace the $100,000 figure specifically provided
therein. Each party State and subdivision thereof may
make the same election available to taxpayers additional
to those specified in this paragraph.
Coverage
3. NothMg in this Article relates to the reporting or
payment of any tax other than an income tax.
Article IV. Division of Income
1. As used in this Article, unless the context otherwise
requires:
218
(a) "Business income" means income arising from trans
actions and activity in the regular course of the tax
payer's trade or business and includes income from tangible
and intangible property if the acquisition, management,
and disposition of the property constitute integral parts
of the taxpayer's regular trade or business operations.
(b) "Commercial domicile" means the principal place
from which the trade or business of the taxpayer is dir
ected or managed.
(c) "Compensation" means wages, s&&aries, commissions
and any other form of remuneration paid to employees for
personal services.
(d) "Financial organization" means any bank, trust
company, savings bank, industrial bank, land bank, safe
deposit company, private banker, savings and loan associa
tion, credit union, cooperative bank, small loan company,
sales finance company, investment company, or any type of
insurance company.
(e) "Nonbusiness income" means all income other than
bus ine s s inc ome.
(f) "Public utility" means any business entity (l)
which owns or operates any plant, equipment, property,
franchise, or license for the transmission of communica
tions, transportation of goods or person?, except by pipe
line, or the production, transmission, sale, delivery,
or furnishing of electricity, water or steamj and (2) whose
rates of charges for goods or services have been establish
ed or approved by a Federal, State or local government or
governmental agency.
(g) "Sales" means all gross receipts of the taxpayer
not allocated under paragraphs of this Article.
(h) "State" means any State of the United States, the
District of Columbia, the Commonwealth of Puerto Rico, any
Territory or Possession of the United States, and any
foreign country or political subdivision thereof.
(i) "This State" means the State in which the relevant
tax return is filed, or, in the case of application of this
Article to the apportionment and allocation for local tax
purposes, the subdivisions or local taxing district in
which the relevant tax return is filed.
2. Any taxpayer having income from business activity
which is taxable both within and without this State, other
219
than activity as a financial organization or public
utility or the rendering of purely personal services by
an individual, shall allocate and apportion his net income
as provided in this Article. If a taxpayer has income
from business activity as a public utility but derives the
greater percentage of his income from activities subject
to this Article, the taxpayer may elect to allocate and
apportion his entire net income as provided in this
Article.
3. For purposes of allocation and apportionment of income
under this Article, a taxpayer is taxable in another
State if in that State he is subject to a net income
tax, a franchise tax measured by net income, a franchise
tax for the privilege of doing business, or a corporate
stock tax, or (2) that State has Jurisdiction to subject
the taxpayer to a net income tax regardless of whether,
in fact, the State does or does not.
4. Rents and royalties from real or tangible personal
property, capital gains, interest, dividends or patent
or copyright royalties, to the extent that they constitute
nonbusiness income, shall be allocated as provided in
paragraphs 5 through 8 of this Article.
5. (a) Net rents and royalties from real property
located in this State are allocable to this State.
(b) Net rents and royalties from tangible personal
property are allocable to this State: (1) if and to the
extent that the property is utilized in this State, or
( 2) in their entirety if the taxpayer's commercial domicile
is in this State and the taxpayer is not organized under
the laws of or taxable in the State in which the property
is utilized.
(c) The extent of utilization of tangible personal
property in a State is determined by multiplying the
rents and royalties by a fraction, the numerator of which
is the number of days of physical location of the pro
perty in the State during the rental or royalty period in
the taxable year and the denominator of which is the num
ber of days of physical location of the property every
where during all rental or royalty periods in the taxable
year. If the physical location of the property during the
rental or royalty period is unknown or unascertainable by
the taxpayer, tangible personal property is utilized in
the State in which the property was located at the time
the rental or royalty payer obtained possession.
6. (a) Capital gains and losses from sales of real
220
property located in this State are allocable to this
State.
(b) Capital gains and losses from sales of tangible
personal property are allocable to this State if (1) the
property had a situs in this State at the time of the sale*
or (2) the taxpayer’s commercial domicile is in this State
and the taxpayeriis not taxable in the State in which the
property had a situs. " _
(c) Capital gains and losses from sales of intangible
personal property are allocable to this State if the tax
payer’ s commercial domicile is in this State.
7. Interest and dividends are allocable to this State if
the taxpayer's commercial domicile is in this state.
8. (a) Patent and copyright royalties are allocable to
this State: (1) if and to the extent that the patent or
copyright is utilized by the payer in this State, or (2)
if and to the extent that the patent (or) copyright is
utilized by the payer in a State in which the taxpayer is
not taxable and the taxpayer's commercial domicile is in
this State.
(b) A patent is utilized in a State to the extent that
it is employed in production, fabrication, manufacturing,
or other processing in the State or to the extent that a
patented product is produced in the State. If the basis
of receipts from patent royalties does not permit alloca
tion to States or if the accounting procedures do not
reflect States of utilization, the patent is utilized in
the State in which the taxpayer's commercial domicile is
located.
(c) A copyright is utilized In a State to the extent
that printing or other publication originates in the
State. If the basis of receipts from copyright royalties
does not permit allocation to States or if the accounting
procedures do not reflect States of utilization, the
copyright is utilized in the State in which the taxpayer's
commercial domicile is located.
9- All business income shall be apportioned to this State
by multiplying the income by a fraction, the numerator of
which is the property factor plus the payroll factor plus
the sales factor, and the denominator of which is three.
10. The property factor is a fraction, the numerator of
which is the average value of the taxpayer's real and
tangible personal property owned or rented and used in this
221
State during the tax period and the denominator of which
is the average value of all the taxpayer’s real and tang
ible personal property owned or rented and used during the
tax period.
11. Property owned by the taxpayer is valued at its
original cost. Prpperty rented by the taxpayer is valued
at eight times the net annual rental rate. Net annual
rental rate is the annual rental rate paid by the taxpayer
less any annual rental rate received by the taxpayer from
subrentals.
12. The average value of property shall be determined by
averaging the values at the beginning and ending of the
tax period but the tax administrator may require the
averaging of monthly values during the tax period if
reasonably required to reflect properly the average value
of the taxpayer's property.
13. The payroll factor is a fraction, the numerator of
which is the total amount paid in this State during the
tax period by the taxpayer for compensation and the de
nominator of which is the total compensation paid every
where during the tax period.
14. Compensation is paid in this State if:
(a) the individual's service is performed entirely
within the state1
(b) the individual’s service is performed both within
and without the State, but the service performed without
the State is incidental to the individual's service within
the State; o r
(c) some of the service is performed in the State and
(1) the base of operations or, if there is no base of
operations, the place from which the service is directed
or controlled is in the State, or (2) the base of opera
tions or the place from which the service is directed or
controlled is not in any State in which some part of the
service is performed, but the individual's residence is
in this State.
15. The sales factor is a fraction, the numerator of which
is the total sales of the taxpayer in this State during
the tax period, and the denominator of which is the total
sales of the taxpayer everywhere during the tax period.
1 6. Sales of tangible personal property are in this State
if:
222
(a) the property is delivered or shipped to a
purchaser, other than the United States Government, within
this State regardless of the f.o.b. point or other condi
tions of the sale; or
(b) the property is shipped from an office, store,
warehouse, factory, or other place of storage in this
State and (l) the purchaser is the United States Govern
ment or (2) the taxpayer is not taxable in the State of
the purchaser.
17. Sales, other than sales of tangible personal property,
are in this State if:
(a) the income-producing activity is performed both in
this State; or
(b) the income-producing activity is performed both in
and outside this State and a greater proportion of the
income-producing activity is performed in this State than
in any other State, based on costs of performance.
18. If the allocation and apportionment provisions of this
Article do not fairly represent the extent of the tax
payer’s business activity in this State, the taxpayer may
petition for or the tax administrator may require, in
respect to all or any of the taxpayer's business activity,
if reasonable:
(a) separate accounting;
(b) the exclusion of any one or more of the factors;
(c) the inclusion of one or more additional factors
which will fairly represent the taxpayer's business
activity in this State; or
(d) the employment of any other method to effectuate an
equitable allocation and apportionment of the taxpayer's
income.
Article VI. The Commission
Organization and Management
1. (a) The Multistate Tax Commission is hereby esta
blished. It shall be composed of one "member1 ' from each
party State who shall be the head of the State agency
charged with the administration of the types of taxes to
which this compact applies. If there is more than one
such agency the State shall provide by law for the selec
tion of the Commission member from the heads of the rele
vant agencies. State law may provide that a member of the
223
Commission be represented by an alternate but only if
there is on file with the Commission written notification
of the designation and identity of the alternate. The
Attorney General of each part State or his designee, or
other counsel if the laws of the party State specifically
provide, shall be entitled to attend the meetings of
the Commission, but shall not vote. Such Attorneys
General, designees, or other counsel shall receive all
notices of meetings required under paragraph 1(e) of this
Article.
(b) Each party State shall provide by law for the
selection of representatives from its subdivisions affec
ted by this compact to consult with the Commission member
from that State.
(c) Each member shall be entitled to one vote. The
Commission shall not act unless a majority of the members
are present, and no action shall be binding unless
approved by a majority of the total number of members.
(d) The Commission shall adopt an official seal to be
used as it may provide.
(e) The Commission shall hold an annual meeting and
such other regular meetings as its bylawsramay provide and
such special meetings as its Executive Committee may
determine. The Commission bylaws shall specify the dates
of the annual and any other regular meetings, and shall
provide for the giving of notice of annual, regular and
special meetings. Notices of special meetings Shall
include the reasons therefor and an agenda of the items
to be considered.
(f) The Commission shall elect annually, from among
its members, a Chairman, a Vice Chairman and a Treasurer.
The Commission shall appoint an Executive Director who
shall serve at its pleasure, and it shall fix his duties
and compensation. The Executive Director shall be
Secretary of the Commission. The Commission shall make
provision for the bonding of such of its officers and
employees as it may deem appropriate.
(g) Irrespective of the civil service, personnel or
other merit system laws of any party State, the Executive
Director shall appoint or discharge such personnel as may
be necessary for the performance of the functions of the
Commission and shall fix their duties and compensation.
The Commission bylaws shall provide for personnel
policies and programs.
224
(h) The Commission may borrow, accept or contract
for the services of personnel from any State, the United
States, or any other governmental entity.
(i) The Commission may accept for any of its purposes
and functions any and all donations and grants of money,
equipment, supplies, materials and services, conditional
or otherwise, from any governmental entity, and may
utilize and dispose of the same.
(j) The Commission may establish one or more offices
for the transacting of its business.
(k) The Commission shall adopt bylaws for the conduct
of its business. The Commission shall publish its bylaws
in convenient form, and shall file a copy of the bylaws
and any amendments thereto with the appropriate agency
or officer in each of the party States.
(1) The Commission annually shall make to the
Governor and legislature of each party State a report
covering its activities for the preceding year. Any dona
tion or grant accepted by the Commission or services
borrowed shall be reported in the annual report of the
Commission, and shall include the nature, amount and
conditions, if any, of the donation, gift, grant or
services borrowed and the identity of the donor or lender.
The Commission may make additional reports as it may deem
desirable.
Committees
2. (a) To assist in the conduct of its business when the
full Commission is not meeting, the Commission shall have
an Executive Committee of seven members, including the
Chairman, Vice Chairman, Treasurer and four other members
elected annually by the Commission. The Exective Committee
subject to the provisionssof this Compact and consistent
with the policies of the Commission, shall function as
provided in the bylaws of the Commission.
(b) The Commission may establish advisory and techni
cal committees, membership on which may include private
persons, and public officials, in furthering any of its
activities. Such committees may consider any matter of
concern to the Commission, including problems of special
interest to any party State and problems dealing with
particular types of taxes.
(c^ The Commission may establish such additional
committees as its bylaws may provide.
225
Powers
3. In addition to powers conferred elsewhere in this
compact, the Commission shall have power to:
(a) Study State and local tax systems and particular
types of State and local taxes.
(b) Develop and recommend proposals for an increase in
uniformity or compatibility of State and local tax laws
with a view toward encouraging the simplification and
improvement of State and local tax law and administration.
(c) Compile and publish information as in its judgment
would assist the party States in implementation of the
compact and taxpayers in complying with State and local
tax laws.
(d) Do all things necessary and incidental to the
administration of its functions pursuant to this compact.
Finance
4. (a) The Commission shall submit to the Governor or
designated officer of officers of each party State a bud
get of its estimated expenditures for such period as may
be required by the laws of that State for presentation to
the legislation thereof.
(b) Each of the Commission's budgets of estimated
expenditures shall contain specific recommendations of the
amounts to be appropriated by each of the Party States.
The total amount of appropriations requested under any
such budget shall be apportioned among the party States as
follows: one-tenth in equal shares; and the remainder in
proportion to the amount of revenue collected by each
party State and its subdivisions from income taxes, capital
stock taxes, gross receipts taxes, sales and use taxes.
In determining such amounts, the Commission hhall employ
such available public sources of information as, In their
judgment, present the most equitable and accurate compari
sons among the party States. Each of the Commission's
budgets of estimated expenditures and requests for appro
priations shall indicate the sources used in obtaining
information employed in applying the formula contained in
this paragraph.
(c) The Commission shall not pledge the credit of any
party State. The Commission may meet any of its obligations
in whole or in part with funds available to it under
paragraph (1) (i) of this Article; provided that the
226
Commission takes specific action setting aside such funds
prior to incurring any obligation to be met in whole or
in part in such manner. Except where the Commission makes
use of funds available to it under paragraph 1 (i)* the
Commission shall not incur any obligation prior to the
allotment of funds by the party States adequate to meet
the same.
(d) The Commission shall keep accurate accounts of all
receipts and disbursements. The receipts and disburse
ments of the Commission shall be subject to the audit and
accounting procedures established under its bylaws. All
receipts and disbursements of funds handled by the
Commission shall be audited yearly by a certified or li
censed public accountant and the report of the audit shall
be included in and become part of the annual report of the
Commission.
(e) The accounts of the Commission shall be oped at
any reasonable time for inspection by duly constituted
officers of the party States and by any persons authorized
by the Commission.
(f) Nothing contained in this Article shall be con
strued to prevent Commission compliance with laws relating
to audit or inspection of accounts by or on behalf of any
government contributing to the support of the Commission.
Article VII. Uniform Regulations and Forms
1. Whenever any two or more party States* or subdivisions
of party States* have uniform or similar provisions of law
relating to an income tax* capital stock tax* gross
receipts tax* sales or use tax* the Commission may adopt
uniform regulations for any phase of the administration of
such law* including assertion of Jurisdiction to tax* or
prescribing uniform tax forms. The Commission may also act
with respect to the provisions of Article IV of this com
pact.
2. Prior to the adoption of any regulation* the Commission
shall:
(a) As provided in its bylaws* hold at least one public
hearing on due notice to all affected party States and
subdivisions thereof and to all taxpayers and other per
sons who have made timely request of the Commission for
advance notice of its regulation-making proceedings.
(b) Afford all affected party States and subdivisions
227
and interested persons an opportunity to submit relevant
written data and views, which shall be considered fully
by the Commission.
3* The Commission shall submit any regulations adopted
by it to the appropriate officials of all party States and
subdivisions to which they might apply. Each such State
and subdivision shall consider any such regulations for
adoption in accordance with its own laws and procedures.
Article VIII. Interstate Audits
1. This Article shall be in force only in those party
States that specifically provide for by statute.
2. Any party State or subdivision thereof desiring to
make or participate in an audit of any accounts, books,
papers, records or other documents may request the
Commission to perform the audit on its behalf. In re
sponding to the request, the Commission shall have access
to and may examine, at any reasonable time, such accounts,
books, papers, records, and other documents and any rele
vant property or stock of merchandise. The Commission
may enter into agreements with party States or their sub©
divisions for assistance in performance of the audit. The
Commission shall make charges, to be paid by the State or
local government or governments for which it performs the
service, for any audits performed by it in order to re
imburse itself for the actual costs incurred in making the
audit.
3 . The Commission may require the attendance of any per
son within the State where it is conducting an audit or
part thereof at a time and place fixed by it within such
State for the purpose of giving testimony with respect to
any account, book, paper, document, other record, property
or stock of merchandise being examined in connection with
the audit. If the person is not within the jurisdiction,
he may be required to attend for such purpose at any time
and place fixed by the Commission within the State of which
he is a resident: provided that such State has adopted
this Article.
4. The Commission may apply to any court having power to
issue compulsory process for orders in aid of its powers
and responsibilities pursuant to this Article and any and
all such courts shall have jurisdiction to issue such
orders. Failure of any person to obey any such order
shall be punishable as contempt of the issuing court. If
the party or subject matter on account of which the Com
mission seeks an order Is within the jurisdiction of the
228
court to which application is made, such application may
he to a court in the State or subdivision on behalf of
which the audit is being made or a court in the State in
which the object of the order being sought is situated.
The provisions of this paragraph apply only to courts in
a State that has adopted this Article.
5. The Commission may decline to perform any audit re
quested if its findings that its available personnel or
other resources are insufficient for the purpose or that*
in the terms requested, the audit is impracticable of
satisfactory performance. If the Commission, on the basis
of its experience, has reason to believe that an audit of
a particular taxpayer, either at a particular time or on
a particular schedule, would be of interest to a number
of party States or their subdivisions, it may offer to
make the audit or audits, the offer to be contingent on
sufficient participation therein as determined by the
Commission.
6 . Information obatined by any audit pursuant to this
Article shall be confidential and available only for tax
purposes to party States, their subdivisions or the United
States. Availability of information shall be in accordance
with the laws of the States or subdivisions on whose
account the Commission performs the audit, and only through
the appropriate agencies or officers of such States or
subdivisions. Nothing in this Article shall be construed
to require any taxpayer to keep records for any period not
otherwise required by law.
7. Other arrangements made or authorized pursuant to law
for cooperative audit by or on behalf of the party States
or any of their subdivisions are not superseded or in
validated by this Article.
8. In no event shall the Commission make any charge
against a taxpayer for an audit.
9. As used in this Article, "tax'1 in addition to the
meaning ascribed to it in Article II, means any tax or
license fee imposed in whole or in part for revenue pur
poses .
Article IX. Arbitration
1. Whenever the Commission finds a need for settling dis
putes concerning apportionments and allocations by arbi
tration, it may adopt a regulation placing this Article in
.effect, notwithstanding the provisions of Article VII.
229
2. The Commission shall select and maintain an Arbitra
tion Panel composed of officers and employees of State
and local governments and private persons who shall be
knowledgeable and experienced in matters of tax law and
administration.
3. Whenever a taxpayer who has elected to employ Article
IV, or whenever the laws of the party State or subdivision
thereof* are substantially identical with the relevant pro
visions of Article IV, the taxpayer, by written notice to
the Commission and to each party State os subdivision
thereof that would be affected, may secure arbitration
of an apportionment or allocation, if he is dissatisfied
with the final administrative determination of the tax
agency of the State or subdivision with respect thereto
on the ground that it would subject him to double or
multiple taxation by two or more party States or subdi
visions thereof. Each party State and subdivision thereof
hereby consents to the arbitration as provided herein, and
agrees to be bound thereby.
4. The Arbitration Board shall be composed of one person
selected by the taxpayer, one by the agency or agencies
involved, and one member of the Commission's Arbitration
Panel. If the agencies involved are unable to agree on
the person to be selected by them, such person shall be
selected by lot from the total membership of the Arbitra
tion Panel. The two persons selected for the Board in
the manner provided by the foregoing provisions of this
paragraph shall jointly select the third member of the
Board, If they are unable to agree on the selection, the
third member shall be selected by lot from among the total
membership of the Arbitration Panel. No member of a
Board selected by lot shall be qualified to serve if he is
an officer or employee or is otherwise affiliated with any
party to the arbitration proceeding. Residence within
the jurisdiction of a party to the arbitration proceeding
shall not constitute affiliation within the meaning of
this paragraph.
5. The Board may sit in any State or subdivision party to
the proceeding, in the State of the taxpayer's incorpora
tion, residence or domicile, in any State where the tax
payer does business, or in ^ny place that it finds most
appropriate for gaining access to evidence relevant to the
matter before it.
6. The Board shall give" due notice of the times and
places of its hearings. The parties shall be entitled to
be heard, to.present evidence, and to examine and cross-
examine witnesses. The Board shall act by majority vote.
230
7. The Board shall have power to administer oaths, take
testimony, subpoena and require the attendance of witness
es and the production of accounts, books, papers, records,
and other documents, and issue commissions to take testi
mony. Subpoenas may be signed by any member of the Board.
In case of failure to obey a subpoena, and upon application
by the Board, any judge of a court of competent jurisdic
tion of the State in which the Board is sitting or in
which the person to whom the subpoena is directed may be
found may make an order requiring compliance with the sub
poena, and the court may punish failure to obey the order
as a contempt. The provisions of this paragraph apply
only in States that have adopted this Article.
8. Unless the parties otherwise agree the expenses and
other costs of the arbitration shall be assessed and
allocated among the parties by the Board in such manner as
it may determine. The Commission shall fix a schedule of
compensation for members of Arbitration Boards and of other
allowable expenses and costs. No officer or employee of
a State or local government who serves as a member of the
Board shall be entitled to compensation therefor unless he
is required on account of his service to forego the reg
ular compensation attached to his public employment, but
any such Board member shall be entitled to expenses.
9. The Board shall determine the disputed apportionment
or allocation and any matters necessary thereto. The
determinations of the Board shall be final for purposes of
making the apportionment or allocation, but for no other
purpose.
10. The Board shall file with the Commission and with each
tax agency represented in the proceeding: the determina
tion of the Board; the Board's written statement of its
reasons thereof; the record of the Board's proceedings;
and any other documents required by the arbitration rules
of the Commission to be filed.
11. The Commission shall publish the determinations of
Boards together with the statements of the reasons therefor^
12. The Commission shall adopt and publish rules of pro
cedure and practice and::shall file a copy of such rules and
of any amendment thereto with the appropriate agency or
officer in each of the party States.
13. Nothing contained herein shall prevent at any time a
written compromise of any matter or matters in dispute, if
otherwise lawful, by the parties to the arbitration pro
ceeding.
231
Article X. Entry into Force and Withdrawal
1. This compact shall enter into force when enacted into
law by any seven States. Thereafter, this compact shall
become effective as to any other State upon its enactment
thereof. The Commission shall arrange for notification of
all party States whenever there is a new enactment of the
compact.
2. Any party State may withdraw from this compact by
enacting a statute repealing the same. No withdrawal shall
affect any liability already incurred by or chargeable to
a party State prior to the time of such withdrawal.
3. No preceeding commenced before an Arbitration Board
prior to the withdrawal of a State and to which the
withdrawing State or any subdivision thereof is a party
shall be discontinued or terminated by the withdrawal
nor shall the Board thereby lose jurisdiction over any of
the parties to the proceeding necessary to make a binding
determination therein.
Article XI. Effect on Other Laws and Jurisdiction
Nothing in this compact shall be construed to:
(a) Affect the power of any State or subdivision
thereof to fix rates of taxation, except that a party
State shall be obligated to implement Article III 2 of
this compact.
(b) Apply to any tax or fixed fee imposed for the
registration of a motor vehicle or any tax on motor fuel,
other than a sales tax: provided that the definition of
"tax'1 in Article VIII 9 may apply for the purposes of that
Article and the Commission's powers of study and recommen
dation pursuant to Article VI 3 may apply.
(c) Withdraw or limit the jurisdiction of any State or
local court or administrative officer or body with respect
to any person, corporation or other entity or subject
matter, except to the extent that such jurisdiction is
expressly conferred by or pursuant to this compact upon
another agency or body.
(d) Supersede or limit the jurisdiction of any court
of the United States.
Article XII. Construction and Severability
This compact shall be liberally construed so as to
232
effectuate the purposes thereof. The provisions of this
compact shall be severable and if any phrase, clause,
sentence of provision of this compact is declared to be
contrary to the constitution of any State or of the United
States or the applicability thereof to any government,
agency, person or circumstance is held invalid, the
validity ^of the remainder of this compact and the applica
bility thereof to any government, agency, person or cir
cumstance shall not be affected thereby. If this compact
shall beMield contrary to the constitution of any State
participating therein, the compact shall remain in full
force and effect as to the remaining party States and in
full force and effect as to the State affected as to all
severable matters.
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242
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Commerce: The Current Status," Southwestern Law
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Articles in Collections
1. Dexter, William D. "The Case Against Federal Inter
vention, " State and Local Taxes on Business. Tax
Institute of America Symposium, October g8--30,
1964. Princeton: Tax Institute of America, 1 9 6 5.
9 8-1 1 2.
2. Drabkin, Murray. "The Role of Myth in State Taxation
of Interstate Business," State and Local Taxes on
Business. Tax Institute of America symposium,
October 28-30, 1964. Princeton: Tax Institute
of America, 1 9 6 5. 5 5-6 6.
3 . Hellerstein, Jerome R. "Allocation and Nexus in State
Taxation of Interstate Businesses," State and
Local Taxes on Business. Tax Institute of
America symposium, October 2 8-3 0, 1964. Princeton:
Tax Institute of America, 1965* 67-97*
4. Netzer, Dick. "Financial Needs and Resources Over the
Next Decadej State and Local Governments," Public
Financesj Needs, Sources and Utilization. Na
tional jEtareau of Economic Research, 1 9 6 1. 23-77*
5 . Peehman, Joseph A. "Financing State and Local Govern
ment, " Proceedings of a Symposium on Federal
Taxationl New York: The American Bankers Ass oc i a-
tion, 1965 * 71-108.
6. Tax Institute of America. State and Local Taxes on
Business. Symposium, Oc t ob e r 2 6-30,' 1964.
Princeton: Tax Institute of America, 1 9 6 5.
244
Unpublished Materials
1. Morss, Elliott R. A Study of How Corporate Income
Should Be Apportioned for Taxation by States.
Unpublished Ph.D. dissertation, Johns Hopkins
University, Baltimore, Maryland, 19&3-
2. Somers, Harold M. "The Heller Plan, A Critique and
an Alternative," Institute of Government and
Public Affairs, University of California, Los
Angeles, November 1 9 6 5.
United States Statutes
1. Public Law 86-272, 73 Stat. 555(1959)> Section 201,
as amended 15 U.S.C. 381-384 ^Supp. II. 1 9 6 1).

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Creator Trainer, Patricia Dillon (author)

Core Title State Taxation Of Interstate Corporate Income

Degree Doctor of Philosophy

Degree Program Economics

Publisher University of Southern California (original), University of Southern California. Libraries (digital)

Tag Economics, Finance,OAI-PMH Harvest

Language English

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Advisor Morgner, Aurelius (committee chair), Elliott, John E. (committee member), Myers, James H. (committee member)

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