Methods of Allocating Income
The statute that enables the State of California to enforce the unitary method is found in the Revenue and Taxation Code.
It states that when the income of a taxpayer subject to the Bank and Corporation Tax Law is derived from or attributable to sources both within and outside California, the tax must be measured by the net income attributed to sources within California.
Consequently, the statute is only applicable when the company has operations both within and without California.
If all activities are restricted to California no allocation is necessary.
The formula used is somewhat arbitrary but it is easily computed.
The numerator consists of the property, payroll and sales attributed to California.
The denominator includes the same factors but in the aggregate for all company locations.
The three factors are given equal weight.
Mathematically, the formula is expressed: CA Property CA Payroll CA Sales _____________ + _____________ + _____________ Total Property Total Payroll Total Sales ___________________________________________ 3 This fraction is multiplied by total net income to arrive at California taxable income.
The methods of allocating income can best be illustrated by examples: 1.
Corporation A purchases goods that it sells in Nevada and California.
Total income earned by A must be apportioned between California and Nevada.
2.
Corporation A operates an oil well in Colorado, selling oil at the well.
A's administrative offices are located in California.
Income may be attributed to California because some of the property and payroll is located in California.
3.
Corporation A purchases produce in California that it sells in Maine.
No receipts are generated by A's activities in California, but A's activity in California contribute to the net income it earns.
Some of A's income is attributed to California.
4.
Corporation A, which is incorporated and conducts all its activities in Ohio, receives income in the form of dividends from corporation B.
B conducts all its operations in, and derives all of its income from California.
Corporation A has no activities in California.
A will be taxable on the dividend income only in Ohio because that is where its activities are located.
When international companies are involved, the unitary method is still applicable.
The method is applicable to businesses located overseas with subsidiaries in California or California companies with operations overseas.
There exists quite a bit of room for companies subject to the unitary rules to manipulate their activities in order to reduce their California tax burden.
Personal property and warehouses can be located in sates with little or no state income tax.
This will reduce the percentage of property included as California property resulting in a smaller fraction to be applied to total income and a smaller aggregate tax liability.
Also, manufacturing facilities and corporate headquarters which involve substantial payroll can be located in jurisdictions outside the state.
Enforcement of the unitary tax method is a problem.
How can California auditors verify property located in other states at a justifiable cost? In 1966 California enacted the Uniform Division of Income for Tax Purposes Act (UDITPA).
Under the UDITPA, all non-business income is allocated to the state it originates in and only business income is apportioned between states.
This allows consistency and uniformity between states and assists auditors in determining the proper tax.
To further assist in the audit function, California joined the Multi-State Tax Compact.
Eighteen states have joined resources to audit companies located in multiple states.
By performing one combined audit any resulting adjustments can be applied uniformly between states.
The manpower required to perform the audit is reduced and the companies do not have to be burdened by multiple audits performed by each separate state.
It states that when the income of a taxpayer subject to the Bank and Corporation Tax Law is derived from or attributable to sources both within and outside California, the tax must be measured by the net income attributed to sources within California.
Consequently, the statute is only applicable when the company has operations both within and without California.
If all activities are restricted to California no allocation is necessary.
The formula used is somewhat arbitrary but it is easily computed.
The numerator consists of the property, payroll and sales attributed to California.
The denominator includes the same factors but in the aggregate for all company locations.
The three factors are given equal weight.
Mathematically, the formula is expressed: CA Property CA Payroll CA Sales _____________ + _____________ + _____________ Total Property Total Payroll Total Sales ___________________________________________ 3 This fraction is multiplied by total net income to arrive at California taxable income.
The methods of allocating income can best be illustrated by examples: 1.
Corporation A purchases goods that it sells in Nevada and California.
Total income earned by A must be apportioned between California and Nevada.
2.
Corporation A operates an oil well in Colorado, selling oil at the well.
A's administrative offices are located in California.
Income may be attributed to California because some of the property and payroll is located in California.
3.
Corporation A purchases produce in California that it sells in Maine.
No receipts are generated by A's activities in California, but A's activity in California contribute to the net income it earns.
Some of A's income is attributed to California.
4.
Corporation A, which is incorporated and conducts all its activities in Ohio, receives income in the form of dividends from corporation B.
B conducts all its operations in, and derives all of its income from California.
Corporation A has no activities in California.
A will be taxable on the dividend income only in Ohio because that is where its activities are located.
When international companies are involved, the unitary method is still applicable.
The method is applicable to businesses located overseas with subsidiaries in California or California companies with operations overseas.
There exists quite a bit of room for companies subject to the unitary rules to manipulate their activities in order to reduce their California tax burden.
Personal property and warehouses can be located in sates with little or no state income tax.
This will reduce the percentage of property included as California property resulting in a smaller fraction to be applied to total income and a smaller aggregate tax liability.
Also, manufacturing facilities and corporate headquarters which involve substantial payroll can be located in jurisdictions outside the state.
Enforcement of the unitary tax method is a problem.
How can California auditors verify property located in other states at a justifiable cost? In 1966 California enacted the Uniform Division of Income for Tax Purposes Act (UDITPA).
Under the UDITPA, all non-business income is allocated to the state it originates in and only business income is apportioned between states.
This allows consistency and uniformity between states and assists auditors in determining the proper tax.
To further assist in the audit function, California joined the Multi-State Tax Compact.
Eighteen states have joined resources to audit companies located in multiple states.
By performing one combined audit any resulting adjustments can be applied uniformly between states.
The manpower required to perform the audit is reduced and the companies do not have to be burdened by multiple audits performed by each separate state.
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