The Oregon Tax Court recently found that an out-of-state cable television service provider used an appropriate method to compute its sales factor as applied to interstate broadcasters. Specifically, the Court permitted the taxpayer to include the audience for its television networks broadcast over the air in addition to its own cable service subscribers in computing its sales factor. Further, the Court confirmed that certain gains from the taxpayer’s sale of stock, along with associated dividends, were properly treated as non-apportionable nonbusiness income.1
The taxpayer, a major cable television service provider, derives revenue from providing transmissions of cable television, internet, and voice over internet protocol services to subscribers within and outside Oregon. It also operates a group of national television networks and regional sports and news networks. During all of the years at issue, Taxpayer’s television networks were transmitted to audiences via: (i) over-the-air broadcasts, (ii) cable television to persons who subscribed to taxpayer’s cable systems as well as to subscribers to other cable systems, and (iii) direct broadcast satellite to subscribers to those systems. Generally, the taxpayer’s cable systems accounted for only a minority of the networks’ total subscribers. Because payments to the taxpayer depended on the number of network subscribers, it kept detailed records of the number of subscribers for each of its owned networks.
The taxpayer regularly engaged in merger and acquisition activity, including three pertinent transactions in which sales occurred in the tax years at issue. First, the taxpayer acquired an ownership interest in Vodafone Group PLC (Vodafone) in 2002, which it disposed of in a series of transactions beginning shortly after the purchase.2 The last remaining portion of the stock was sold at a gain in 2007. The taxpayer retained ownership of Vodafone’s dividend-paying preferred shares and received dividends from 2007 to 2012. Second, the taxpayer acquired stock of Time Warner, Inc. (Time Warner) in a conversion transaction in 2005. During the 2007 tax year, the taxpayer recognized a gain from the disposition of the stock and received related dividends.3 Finally, the taxpayer acquired a controlling interest in NBCUniversal, LLC (NBCU) in 2011, resulting in the taxpayer holding an indirect 15.8% partnership interest in A&E Television Networks LLC (A&E). Following several transactions, the taxpayer executed a redemption agreement resulting in a gain from the sale of a portion of its ownership interest in A&E in 2012. The taxpayer treated the gains and dividends from the Vodafone, Time Warner, and A&E transactions as non-apportionable nonbusiness income not allocable to Oregon.
Consolidation of MTC / Oregon audits
The Multistate Tax Commission (MTC) audited the taxpayer’s 2007-2009 tax years and recommended various adjustments to its Oregon corporation excise tax returns, including: (i) an increase to the Oregon apportionment percentage; and (ii) a reclassification of certain items of income from nonbusiness to business. In response to the MTC audit, the Oregon Department of Revenue (Department) issued notices of deficiency. The taxpayer appealed, resulting in an initial Oregon Tax Court hearing in 2015. A threshold issue addressing apportionment of the taxpayer’s taxable income as an interstate broadcaster ultimately reached the Oregon Supreme Court, which affirmed the Tax Court’s ruling that it was required to apportion all of its revenue using an audience or subscriber factor in accordance with the state’s specific broadcaster apportionment statutes, rather than bifurcating its revenue streams for state apportionment purposes, except for receipts from sales of real or tangible personal property.4
During the pendency of the litigation covering the taxpayer’s 2007-2009 tax years, the Department audited the taxpayer for the 2010-2012 tax years and made similar adjustments, issuing a corresponding notice of deficiency with respect to the same two primary issues. The taxpayer appealed and the case was held in abeyance pending the Oregon Supreme Court’s decision on the threshold apportionment issue. Once this decision was issued, the cases were consolidated so that the Oregon Tax Court could address all issues encompassing the taxpayer’s 2007-2012 tax years.
Oregon Tax Court decision
The Oregon Tax Court addressed two primary issues in its lengthy decision. Given the requirement for the taxpayer to apportion most of its sales via broadcaster apportionment, the Court considered whether the taxpayer should use data from both of its broadcast television and cable network business segments, or limit the calculation to data from its own subscribers. The Court also analyzed whether gains from the sale of the taxpayer’s ownership interests in Vodafone, Time Warner, and A&E, and dividends from its ownership of Vodafone and Time Warner stock, were properly treated as non-apportionable nonbusiness income. In addition to these primary issues, the Court also considered a statute of limitations issue relating to net operating loss (NOL) carryforwards and whether the Texas Margin Tax qualified as an income tax subject to addback in the calculation of Oregon net income.
Oregon uses a single sales factor to apportion income to the state.5 In general, gross receipts from services are sourced to Oregon if a greater proportion of the income producing activity is performed in the state based on costs of performance.6 However, interstate broadcasters are subject to special apportionment provisions.7 For the relevant tax years, an interstate broadcaster’s gross receipts from broadcasting were apportioned based on the ratio that its audience or subscribers located in Oregon bore to its total audience or subscribers located both within and outside the state.8
While the Department and the taxpayer agreed about which particular audience members or subscribers were located in Oregon for sales factor purposes, they disagreed as to how to determine the taxpayer’s “audience.” The taxpayer sought to use data from both its broadcast television and cable network business segments to compute its sales factor. Specifically, the taxpayer determined the numerator of its audience/subscriber ratio as the sum of: (i) the Oregon audience and subscribers who received one or more of its television networks by whatever means;9 and (ii) the Oregon audience and subscribers who received its cable service, but did not receive any of its networks. The Department argued that the taxpayer was a cable network and primarily engaged in a subscription service, so it could only use its own cable subscribers in computing the numerator and denominator of its ratio, without using other audience indicators resulting from other broadcasting activities. In considering this argument, the Court determined that the Department failed to “explain why the audience and subscribers can be combined in the denominator of the ratio but not the numerator.” Further, the Court reasoned that requiring an over-the-air broadcasting audience to be determined based on cable subscribers seemed inconsistent with the intent of the statute. Finally, the Court relied upon the text, context, and legislative history of the interstate broadcaster apportionment statutes to conclude that the taxpayer accurately computed its sales factor as required.10
As noted above, the taxpayer treated gains from the sale of ownership interests in Vodafone Group, Time Warner, and A&E, and associated dividends from Vodafone and Time Warner as nonbusiness income not subject to apportionment during the tax years at issue. The Department disagreed and reclassified all of these items as business income subject to apportionment.
Specifically, the taxpayer reasoned that it was not engaged in a unitary business with any of the three businesses and that none of the taxpayer’s ownership interests served an operational function in its business. Therefore, the related income was nonbusiness income. In contrast, the Department argued that the stock holdings served an operational function because merger and acquisition activities were a regular part of the taxpayer’s business. Thus, the related earnings were apportionable business income. Both the taxpayer and the Department recognized that the U.S. Supreme Court’s Allied-Signal decision governed whether the income was subject to apportionment.11 The Court held that the taxpayer’s holding of stock in Vodafone and Time Warner, and the partnership interest in A&E were considered passive investments. Even though the disposition of stock took place within the regular course of the taxpayer’s business, the dividends and gains from Vodafone and Time Warner did not generate apportionable income.
With respect to the gain related to the A&E partnership interest, the Court found that the parties had not provided relevant facts to determine “whether, or in what circumstances, a partnership interest when sold should be treated as an item of intangible property akin to the stock in Allied-Signal, or whether an aggregate theory of partnership applies.” Therefore, it declined to rule as to that issue pending a new motion as to the statutory and constitutional treatment of the A&E interests as partnership interests.12
Statute of limitations for net operating losses
The taxpayer claimed deductions for its 2007-201013 tax years resulting from carrying forward NOLs that it incurred in its 2003-2006 tax years. The Department argued that the taxpayer failed to timely appeal the amount of income or loss reflected in the NOL years and, therefore, lost its right to contest the Department’s adjustments to its carryforward deduction. Further, allowing the taxpayer to contest the adjustment would permit the company to avoid the statute of limitations.
Relying upon the Oregon Supreme Court’s Hillenga14 decision, the Court denied the Department’s motion, finding that the Department had cited no evidence that the taxpayer had failed to timely exercise its appeal rights. The Court found it lacked the ability to determine whether the taxpayer “still has an opportunity to contest its taxable income or loss for the NOL years in an appeal to this court stemming from the notices of deficiency or the alleged refund claim.” The Court noted that the proper value of the NOL carryforward would be determined at trial.
Texas margin tax
Oregon statutes require inclusion of taxes on or measured by net income in calculating Oregon taxable income.15 On its originally filed returns, the taxpayer did not include its Texas Margin Tax paid in this measure as it determined that the tax was not “on or measured by income.” The Department disagreed and argued that the amount must be added back to the taxpayer’s federal taxable income to compute Oregon taxable income. Because the Texas tax statutes allow a deduction for specified costs of goods sold or specified compensation, but not both, and limits the deduction to the lesser of 70 percent of total revenue or total revenue minus $1 million, the Court determined that the limitations are contrary to the definition of net income. Therefore, it determined that the amount of Texas Margin Tax paid by the taxpayer did not need to be added back to compute Oregon taxable income.16
The apportionment issue addressed by the Court in this decision demonstrates how apportionment statutes have been unable to keep pace with conglomerate businesses that have numerous and complex revenue streams. In this instance, the Court was forced to apply apportionment statutes that did not envision the business model developed by this taxpayer. Specifically, the Court noted that the Oregon legislature did not contemplate the situation of a single entity operating both a cable business and an over-the-air network. While the Oregon apportionment rules applicable to interstate broadcasters have since been significantly modified,17 multistate taxpayers and state tax authorities alike are likely to continue to struggle in interpreting industry-specific rules that do not address novel or hybrid fact patterns. Examples of business enterprises that potentially may need to consider the Court’s analysis regarding sales factor apportionment include trucking/logistics companies and internet service providers that also produce and sell content. For entities similarly situated to the taxpayer at issue in this case, one can expect added complexity as streaming services associated with existing broadcasting companies continue to gain market share.
Beyond the issue of apportioning specific revenue streams, the Court’s analysis leaves open the question of whether a company’s sale of a passive interest in an entity should be treated differently for purposes of the business / nonbusiness income determination when the entity being sold is a partnership rather than a corporation. Further, the categorization by the Court of the Texas Margin Tax as not qualifying as a tax “on or measured by income” may lead multistate taxpayers filing in Oregon with gross receipts or hybrid tax liabilities in other states to evaluate whether such taxes should be added back to the Oregon corporation income tax base. Interestingly, the Department has not yet provided guidance regarding whether the Oregon Corporate Activity Tax (CAT), which is modeled after the Texas Margin Tax, is treated as an income tax for this purpose. As a result of this decision, taxpayers should also prospectively consider whether the Oregon CAT payments made for the 2020 tax year should be added back to the Oregon corporation income tax base.
1 Comcast Corporation and Subsidiaries v. Department of Revenue, OR, TC, No. 5265 (Control), TC 5346 (Nov. 25, 2020).
2 During the time the taxpayer held its interest in Vodafone: (i) Vodafone’s headquarters were located in the United Kingdom; (ii) no employees of one company were involved in the day-to-day operations or management of the other; (iii) there were no overlapping members of boards of directors; (iv) the companies did not share common facilities or services; and (v) the taxpayer never pledged its interest in Vodafone as security for repayment of debt.
3 During the time the taxpayer held its interest in Time Warner: (i) the two entities maintained separate headquarters locations; (ii) no employees of one company were involved in the day-to-day operations or management of the other; (iii) there were no overlapping members of boards of directors; (iv) the companies did not share common facilities or services; and (v) the taxpayer never pledged its Time Warner stock as security for repayment of debt.
4 Comcast Corporation and Subsidiaries v. Department of Revenue, OR., SC S064698 (Aug. 16, 2018), affirming Comcast Corp. v. Department of Revenue, OR, TC, No. 5265 (Oct. 11, 2016). See GT SALT Alert: Oregon Supreme Court Affirms Substantial Nexus and Subscriber-Based Sourcing Provisions.
5 OR. REV. STAT. § 314.650.
6 OR. REV. STAT. § 314.665(4). For tax years beginning on or after January 1, 2018, Oregon replaced its COP apportionment method with a market-based apportionment method. OR. REV. STAT. § 314.0435.
7 OR. REV. STAT. § 314.682.
8 OR. REV. STAT. § 314.684(4).
9 To determine this number, the taxpayer used two sets of data: (i) for its over-the-air network, annual reports prepared by the Nielsen Company; and (ii) for all other networks, the relative number of subscribers.
10 The Court also considered whether the Department’s related administrative rule, OR. ADMIN. R. 150-314-0465, required a different result. It found that the rule, like the statutes, does not address the possibility of a single entity operating both an over-the-air network and a cable service.
11 Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768, 787 (1992). In Allied-Signal, New Jersey sought to tax the gain on a corporation’s sale of another publicly traded corporation’s stock. Although the parties stipulated that the two corporations were unrelated business enterprises, the New Jersey Supreme Court determined they formed a “unitary business,” based on its three-factor test for business unity: functional integration, economies of scale, and centralized management. After concluding that the two were unitary, the U.S. Supreme Court found that apportionment was permissible as the assets served an operational, rather than investment, function.
12 The taxpayer did not contest the Department’s attempt to reclassify certain other items to apportionable business income which were originally treated as nonbusiness income. Also, the taxpayer had made an alternate claim for sales factor relief if the Court upheld reclassification of the gains and dividends as business income. With the Court’s decision, this argument was rendered moot with respect to the Time Warner and Vodafone items.
13 The Court noted that it was unclear as to whether the taxpayer claimed the NOL beyond the 2010 tax year.
14 361 P.3d 598 (2015). The decision thoroughly explained the concept of a NOL and held that the mere fact that the NOL year may be closed to audit does not preclude the Department from seeking to recalculate the taxpayer’s taxable income or loss for the NOL year for the limited purpose of determining the correct amount of a carryforward deduction.
15 OR. REV. STAT. § 317.314(1).
16 In its decision, the Court also determined that the taxpayer was not engaged in a single unitary business with a financial services entity and its subsidiaries, finding that the Department had not demonstrated a genuine issue of material fact.
17 For tax years beginning on or after January 1, 2018, Oregon has adopted a market-based apportionment method. Although Oregon still maintains separate apportionment rules applicable to broadcasters, it has significantly modified those statutes, so that separate sets of rules are applicable to: (i) tax years beginning before 2014, (ii) tax years beginning between 2014-2016; and (iii) tax years beginning in 2017 and thereafter.
Jamie C. Yesnowitz
Jamie Yesnowitz, principal serving as the State and Local Tax (SALT) leader within Grant Thornton's Washington National Tax Office, is a national technical resource for Grant Thornton's SALT practice. He has 22 years of broad-based SALT consulting experience at the national and practice office levels in large public accounting firms.
Washington DC, Washington DC
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