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The Multistate Tax Commission Restructures Apportionment of Financials, Seeks to Tax Pass-Throughs

The Multistate Tax Commission (MTC) is in the midst of two projects that focus on the financial services industry. The first project is an effort to amend the recommended formula for the apportionment and allocation o

March 1, 2011

The Multistate Tax Commission (MTC) is in the midst of two projects that focus on the financial services industry. The first project is an effort to amend the recommended formula for the apportionment and allocation of the net income of financial institutions, first adopted by the MTC in 1994. The second project, referred to as the “non-income taxpayer project,” involves the MTC’s drafting of a model statute that would subject certain partnerships and other pass-through entities to an entity level state income tax to the extent their income passes through to an entity that is not itself subject to the state’s income tax.

With respect to the financial institution apportionment and allocation regulation project, a working group of MTC members and staff, together with industry representatives, are engaged in meetings/conference calls and have drafted various proposed amendments. The initial focus of the working group is proposed amendments to the receipts factor.  To date, the most significant proposed amendments relate to credit/debit card-related receipts, including definitional changes and changes to the sourcing of receipts from merchant discount, receipts from automated teller machine services, and receipts from services not otherwise apportioned by specific rules within the regulation. The state members of the working group view the receipts factor phase as complete. However, the financial services industry does not agree with some of the proposed amendments and appears ready to continue to raise its concerns as the project continues through the MTC’s adoption process.

The working group of the financial institution apportionment and allocation regulation project has now moved to its next phase—proposing amendments to the property factor provisions. The primary focus of these amendments relates to the sourcing of loans, including credit card receivables, included in the property factor calculation. A proposal for amending the sourcing rule for these assets, based mainly on a grouping of assets and the costs associated with generating those assets, has been floated by the California representatives. During a working group conference call held on February 2, 2011, the pros and cons of the California proposal were discussed and it was determined that further analysis and drafting is required regarding the sourcing of loans and credit card receivables. After completion of the property factor phase of the project, all of the proposed amendments will be reviewed by the MTC’s Income and Franchise Tax Uniformity Subcommittee as part of the continuing MTC approval process.

With respect to the non-income taxpayer project, the MTC’s Uniformity Committee approved a model statute that provides for a partnership or disregarded entity to be taxed by a state, as if it was a corporation subject to tax in that state, if 50% or more of the capital interests or profits interest in the flow-through entity is owned, directly or indirectly, by an entity that is not subject to that state’s income tax. If the statute applies to the pass-through entity, only the net income that passes through to the income tax-exempt entity would be subject to tax. The draft model statute also provides that a REIT is included within the phrase “partnership or disregarded entity.”

The original target of the non-income taxpayer project was the insurance industry, which is generally subject to premiums taxes, and not state income taxes. However, the model statute is written in such a way as to allow a state to apply the statute to any other industry whose members are not subject to its income tax. Notwithstanding considerable objection by the insurance industry during the early phases of the MTC approval process, the model statute will next be before the MTC’s Executive Committee for its consideration as to whether public hearings should be held. If public hearings are held, it will be interesting to see if the insurance industry renews its opposition efforts and if other similarly impacted industries join in those efforts. 

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