June 2003

Sales Included in the Receipts Factor on NYS Combined Report

By Emanuel Eichler, CPA, Cornick, Garber & Sandler, LLP

New York State Tax Law requires corporations subject to the franchise tax to multiply their business income by a business allocation percentage. This percentage is determined by comparing the in-state amounts for property, receipts, and compensation to the corporation’s total amounts for these factors. Thus, all corporations that own property, pay compensation, or derive business receipts from outside of New York are permitted to apportion their business income subject to New York taxation.


In a recent corporate franchise tax case (Alpharma, Inc., New York Division of Tax Appeals, Administrative Law Judge Unit, DTA No. 817895, September 12, 2002) concerning the business allocation of a combined group of corporations, the state was permitted to include in the numerator of the receipts factor the New York destination sales of companies in the group not subject to the New York corporation franchise tax.

Alpharma, Inc., the parent company, manufactured pharmaceuticals and sold chemicals. Although Alpharma did not have a physical presence in New York, it had a sales representative who spent about 20% of his time in New York working out of the offices of a subsidiary. It was on this basis that Alpharma filed corporation franchise tax returns.

In 1992, the corporation was granted permission to file on a combined basis for New York corporation franchise tax purposes for 1991 and subsequent years. Combined reporting is a method used to determine the portion of total income attributable to each affiliated corporation in a unitary group. The unitary business income of all members of the group is combined, all intercompany transactions are eliminated, and the result is apportioned to the taxing state using the aggregated apportionment factors of the combined group. Even members of the unitary group that have no nexus with that state are included in the combined return.

During the years in question—1993, 1994, and 1995—Alpharma filed a combined return with New York State. Included in the return were a number of affiliated corporations that, although they shipped merchandise to customers in New York State, did not have nexus with the state and were not subject to the corporation franchise tax. These corporations did not pay the fixed-dollar minimum tax on the combined return.

Upon audit, the Department of Taxation and Finance (DTF) assessed additional corporation franchise tax by including the New York destination sales of the nontaxpayer corporations in the numerator of the receipts factor of the business allocation formula of the combined group.

The issue is whether the New York sales of the nontaxpayer corporations are immune from inclusion in the receipts factor of the combined group. The Commerce Clause reserves to Congress the power to regulate commerce between the states. Public Law 86-272 protects a non–New York corporation from income tax if its only business activity in the state is the solicitation of orders for tangible personal property, provided that such orders are accepted and approved out of the state.

Alpharma argued that recognizing the separate status of the non–New York taxpayer corporations is not inconsistent with the inclusion of the net income of those corporations in the net income of the combined group, because the inclusion of their net income may be used to measure the combined net income of the unitary group when it is difficult to measure the net income of each member by separate accounting. The corporation asserted, however, that the receipts of the non–New York affiliates should not be included in the numerator of the combined group’s receipts factor. The corporation noted that combined reporting does not pierce the corporate veil and ignore the separate existence of the non–New York corporations. Thus, the DTF should not be able to impose taxes indirectly where it could not impose these taxes directly.

In reply, the DTF maintained that the sales receipts of the non–New York corporations were properly includable in the numerator of the corporation’s apportionment formula for combined reporting purposes. The DTF argued that the exclusion of the sales of those corporations from the numerator of the receipts factor while including the net incomes of those corporations in the total income reported on the combined return would result in a distortion of the income reported by the combined group. It also took the position that Treasury Regulations section 4-4.7 requires that the combined group’s receipts factor must be computed as if all the corporations on the return were a single corporation in order to meet the intent of section 211(4) of the Tax Law. This section provides that the Commissioner may require the inclusion of non–New York corporations in a combined group in order to properly reflect the tax liability of the combined group. Furthermore, the DTF argued that the state was not asserting its jurisdiction over the non–New York corporations by including their sales receipts in the combined return, but was including their receipts only in order to properly reflect the tax liability of the New York taxpayer members of the combined group.

The administrative law judge ruled that the sales receipts of the non–New York corporations, included in the combined return filed by Alpharma, were not entitled to protection from inclusion in the numerator of the apportionment formula under the Commerce Clause of the Constitution or Public Law 86-272. The judge found that a significant degree of synthesis and integration existed among the corporations in the combined group to provide jurisdictional nexus over the receipts of all of the corporations. Furthermore, the exclusion of those receipts from the apportionment formula would result in distortion of the net income of the combined group. Because the non–New York corporations’ nexus with New York resulting from the integration and unitary relationships among the members in the group far exceeded the minimal connection between their business activities and the state, their receipts were not protected from taxation.

Mark H. Levin, CPA
H.J. Behrman & Company LLP

Contributing Editors:
Henry Goldwasser, CPA
Weiser LLP

Neil H. Tipograph
Imowitz Koenig & Co., LLP

Warren Weinstock, CPA
Marks Paneth & Shron, LLP

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