Arkansas ALJ rejects use of Multistate Tax Compact election without department approval

Terry Gaul
T +1 832 476 5088

Camille Scavone
Kansas City
T +1 816 412 2546

Jamie C. Yesnowitz
Washington, DC
T +1 202 521 1504

Chuck Jones
T +1 312 602 8517

Lori Stolly
T +1 513 345 4540

Priya D. Nair
Washington, DC
T +1 202 521 1546
On December 1, 2017, an administrative law judge (ALJ) for the Arkansas Office of Hearings and Appeals issued two decisions denying taxpayers the use of the Multistate Tax Compact’s equally-weighted three-factor apportionment formula for purposes of the Arkansas corporation income tax. The ALJ explained that the use of an alternative apportionment formula in contravention of Arkansas’ statutory three-factor, double weighted sales factor formula requires a taxpayer to submit a written petition prior to the filing of an original return.1 The ALJ’s decision serves as valuable guidance to taxpayers on the state’s position on this issue given that no Arkansas court has addressed whether multistate taxpayers may use the equally-weighted three-factor apportionment formula established under the Compact. 

Background Arkansas is a member state of the Compact and, as a result, has codified the Compact in full, including Articles III and IV. Article III2 of the Compact allows multistate taxpayers to elect to apportion income in accordance with the state-prescribed apportionment formula or the equally-weighted, three-factor apportionment formula contained in Article IV. In 1995, Arkansas moved from an equally-weighted three-factor apportionment formula to a three-factor, double-weighted sales apportionment formula and amended the state’s codification of Article IV to reflect this change with respect to corporations. The same apportionment method applies to partnerships for tax years beginning on or after January 1, 2018.3

The ALJ matters arose from a series of protests filed by taxpayers with the Arkansas Department of Finance and Administration in which the Compact’s equally-weighted, three-factor apportionment formula was used. The taxpayers took the position that they had the ability to choose between the equally-weighted three-factor apportionment formula contained in the Compact and the three-factor apportionment formula with a double-weighted sales required under Arkansas law,4 without obtaining prior permission from the Department. The taxpayers’ positions rested on the argument that the Compact is a binding contract between states and, as such, the Department could not “unilaterally modify its terms to the detriment of taxpayers.” Conversely, the Department argued that Arkansas law requires taxpayers to use a three-factor apportionment formula with a double-weighted sales and any deviation from this formula represents the use of an alternative apportionment formula that requires prior written approval from the Department. The Department denied the taxpayers’ position and the taxpayers sought administrative hearings to resolve this issue. 

Petition for Alternative Apportionment On appeal, an ALJ for the Arkansas Office of Hearings and Appeals considered whether the taxpayers were required to obtain permission from the Department prior to using an alternative apportionment formula to calculate tax liability. The taxpayers argued that no statutory requirement or valid administrative rule exists which mandated the obtaining of the Department’s permission prior to the use of an alternative apportionment formula. Instead, the statute governing alternative apportionment couches the permission in permissive, rather than mandatory, terms. Specifically, the relevant statute provides that “[i]f the allocation and apportionment provisions…do not fairly present the extent of the taxpayer’s business activity in this state, the taxpayer may petition for” alternative apportionment [emphasis added].5

Rejecting this argument, the ALJ explained that the Department has interpreted state law 6 to impose a mandatory requirement on taxpayers to file a petition for authorization to use an alternative apportionment formula and the Department’s interpretation of a tax statute is entitled to deference unless the interpretation is clearly erroneous. The ALJ cited to the Arkansas Supreme Court’s decision in Leathers v. Jacuzzi,7 in support of the Department’s position that a petition must be submitted in writing prior to the filing of an original return and, furthermore, cannot be submitted in conjunction with the filing of an amended return. The ALJ explained that the Department’s interpretation of state law was not clearly wrong and the Department correctly denied the taxpayers’ position because the taxpayers failed to file a petition prior to utilizing an apportionment formula that deviated from the mandated three-factor double-weighted sales formula.8

On that basis, the ALJ did not substantively consider whether the Compact election itself would be available to a taxpayer that requested permission from the Department. Given the taxpayers’ failure to file a petition prior to filing returns using an alternative apportionment formula, the ALJ did not address the issue of whether the application of the three-factor, double-weighted sales apportionment formula fairly and accurately reflected the taxpayers’ business activity in Arkansas. Likewise, the ALJ concluded that it could not address whether a three-factor, equally weighted apportionment formula could be considered a reasonable alternative to the use of the statutory apportionment formula. 

Commentary The decision by the ALJ is not surprising given the number of states that have rejected taxpayer arguments on the ability to make the apportionment election contained in Article III of the Compact. Shortly after the decision by the ALJ, the Texas Supreme Court, on December 22, 2017, held that a taxpayer could not elect to use the equally-weighted three-factor apportionment formula provided by the Compact, and must use a single receipts factor to compute its franchise tax.9 The Texas decision follows in the wake of a series of other state courts that have consistently rejected taxpayer arguments that they could make the Compact election.10

What is somewhat notable about the decision is that, unlike many other states, Arkansas’ first foray into whether the Compact election could be used by taxpayers ultimately did not actually reach the substantive issue. The ALJ’s decision does imply, however, that taxpayers find themselves in a catch-22 situation as taxpayers are unlikely to be successful in attempting to make this election, given that the Department (like most state tax authorities) does not grant permission for alternative apportionment as a matter of right.11 The Department’s position regarding their view of the Compact election is clearly evident in the ALJ’s decisions published on these matters. It stands to reason that a taxpayer challenge of these decisions in the Arkansas courts would be very difficult to succeed given the need to overcome the threshold issue of “permission” by the Department to use the Compact election, and the substantive issue of whether the Compact election itself may be made.

The position taken by states on the ability to use the Compact election aligns with the overall trend of states emphasizing the sales factor to remain competitive. States are continuing to increase the weight of the sales factor, either through a double-weighted sales factor or a single-sales factor, and the provisions of the Compact itself have been amended in recent years to reflect a more heavily-weighted sales factor to be implemented by Compact members. The drive behind this shift rests on the potential ability of a heavily weighted or single-sales factor to promote job creation and property investment within the state and shift the tax burden to out-of-state companies.

1 Administrative Decision, Docket Nos. 17-369, 17-370, 17-371, 17-459, 17-372 and 17-373, Arkansas Department of Finance & Administration, Office of Hearings & Appeals, December 1, 2017.  
2 ARK. CODE ANN. § 26-5-101, Art. III.
3 ARK. CODE ANN. § 26-51-802(C)(1).
4 ARK. CODE ANN. § 26-51-709.
5 ARK. CODE ANN. § 26-51-718.
6 Id.
7 935 S.W.2d 252 (1996).
8 The ALJ reached the same conclusion on the issue raised in one of the two matters on whether the application of Arkansas’ throwback rule under ARK. CODE ANN. § 26-51-716(b) fairly and accurately reflected its business activity in Arkansas.
9 Graphic Packaging Corp. v. Hegar, Texas Supreme Court, No. 15-0669, December 22, 2017. For a discussion of this case, see GT SALT Alert: Texas Supreme Court Denies Use of Compact’s Three-Factor Formula for Determining Franchise Tax Apportionment.
10 For a discussion of this trend, see GT SALT Alert: Texas Supreme Court Denies Use of Compact’s Three-Factor Formula for Determining Franchise Tax Apportionment.
11 See, for example, Administrative Decision, Docket Nos. 16-202 and 16-213, Arkansas Department of Finance & Administration, Office of Hearings & Appeals, May 27, 2016 and GT SALT Alert: Arkansas ALJ Upholds Director’s Discretionary Power to Require Alternative Apportionment.

The information contained herein is general in nature and based on authorities that are subject to change. It is not intended and should not be construed as legal, accounting or tax advice or opinion provided by Grant Thornton LLP to the reader. This material may not be applicable to or suitable for specific circumstances or needs and may require consideration of nontax and other tax factors. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Grant Thornton LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. No part of this document may be reproduced, retransmitted or otherwise redistributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, re-keying or using any information storage and retrieval system without written permission from Grant Thornton LLP. 

This document supports the marketing of professional services by Grant Thornton LLP. It is not written tax advice directed at the particular facts and circumstances of any person. Persons interested in the subject of this document should contact Grant Thornton or their tax advisor to discuss the potential application of this subject matter to their particular facts and circumstances. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed.