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Alabama tribunal addresses payroll factor issue

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Mark Arrigo
Atlanta
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Veronica Caputo
Atlanta
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Jamie C. Yesnowitz
Washington, D.C.
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Chuck Jones
Chicago
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Lori Stolly
Cincinnati
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Patrick Skeehan
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On June 12, 2020, the Alabama Tax Tribunal issued a decision finding that expenses paid by three taxpayers to an affiliated management services company in exchange for employee services were not includible in the taxpayers’ payroll factor for Alabama apportionment purposes, because the individuals providing services were not considered employees under the state’s payroll factor regulation.1 In reversing a determination by the Alabama Department of Revenue, the Tribunal also ruled that it was not bound to follow the rulings of the Department’s Administrative Law Division (ALD) in existence prior to the creation of the Tribunal. Mark Arrigo, Veronica Caputo and Jamie Yesnowitz of Grant Thornton represented the taxpayers at the Tribunal.

Background The case at issue involved three affiliated companies operating under a parent corporation, Fidelity National Information Services, Inc. (FIS). In 2004, FIS purchased Intercept, Inc. (Intercept), a Georgia corporation engaged in banking services. It later purchased Complete Payment Recovery Services, Inc. (CPRS), a Georgia corporation operating a collections and fraud management business, in 2006. Finally, FIS purchased Metavante Corporation (Metavante), a financial technology services company, in 2009. Intercept, CPRS and Metavante (collectively, the Taxpayers) engaged in business in Alabama and other states.

Separately, FIS formed FIS Management Services LLC (FISM) in 2004. FISM provides services to the companies within FIS’ corporate structure. After acquiring each of the Taxpayers, FIS assigned the Taxpayers’ historic employees to FISM, which was responsible for managing all individuals providing services to the Taxpayers, and to other members of the FIS enterprise. In exchange, the Taxpayers paid FISM for the services provided to their respective companies.

During the 2006-2011 tax years, the Taxpayers apportioned income to Alabama with no payroll factor numerator or denominator.2 The Taxpayers believed that they had no employees in Alabama or elsewhere because the individuals performing work for each company were employees of FISM. Under audit, the Department adjusted the Taxpayers’ Alabama payroll factors to include payments made to FISM in both the numerator and denominator, resulting in increased apportionment to Alabama. The Taxpayers appealed the assessments to the Tribunal, where the appeals were consolidated.

Tribunal decision Before the Tribunal, the Department contended that this issue was previously decided before the ALD of the Department, a predecessor division to the Tribunal, and that the Tribunal was required to follow those decisions in the present case. The Department referred to two prior ALD matters, which found that amounts paid for services provided by employees constituted “compensation paid” and therefore were includible in the taxpayers’ payroll factors.

Tribunal not bound by prior ALD decisions Contending that the Tribunal was bound by prior ALD decisions, the Department cited a previous Tribunal decision in which the Tribunal followed an ALD decision, thereby standing for the proposition that it must follow all ALD decisions.3 The Tribunal disagreed with this argument, pointing to the legislative intent behind the creation of the Tribunal in 2014. Reviewing the statutory language, the Tribunal noted that the Alabama legislature created the Tribunal as an “independent agency” for the purpose of “increas[ing] public confidence in the fairness of the state tax system.”4 By establishing an independent tax tribunal, the legislature intended to provide taxpayers with a “fair and independent dispute resolution forum with the Department.”5 Based on this reading of the law, the Tribunal found that the Alabama legislature clearly intended the Tribunal to be independent from the Department.

The Tribunal also determined that it is required to follow its decisions only, and not those of the ALD. Based on its reading of Alabama law, the Tribunal found that nothing in the statute required it to follow the decisions of the ALD.6 Noting that ALD decisions can be persuasive authority, the Tribunal nonetheless concluded that it is not required to follow them as an agency independent from both the Department and the ALD.

Regulation limiting payroll factor to direct employee payments is valid The Tribunal next considered the issue of whether Alabama’s regulation limiting the state’s payroll factor to payments made directly to employees impermissibly enlarged the Alabama statute covering the same subject. The Department argued that the Tribunal was bound by two previous ALD decisions on the subject, C&D Chemical Products v. Alabama7 and Plantation Pipe Line Company v. Alabama.8 In C&D Chemical, two entities formed a partnership and entered into service agreements with the partnership, under which they provided employees to operate the partnership’s Alabama-based manufacturing facility. In return, the partnership paid the entities a monthly administrative fee based on allocated annual costs. On appeal, the ALD found that the amounts paid by the partnership for services provided by the employees should have been included in the parent company’s Alabama payroll factor, because the amounts constituted “compensation paid.” Likewise, in Plantation Pipe Line, the ALD determined that compensation paid to employees transferred by a pipeline company to a third party company providing operational and administrative functions also should have been included in the pipeline company’s payroll factor.

In both decisions, the ALD examined the Alabama payroll factor regulation at issue, which provided that payments made to independent contractors or any person not classifiable as an employee are excluded from the payroll factor, and that “[o]nly amounts paid directly to employees are included in the payroll factor.”9 The ALD determined that the regulation was invalid because it limited the payroll factor to direct employees, thus exceeding the authority of the Alabama statute speaking to the payroll factor.10 As such, the ALD concluded that payments to indirect employees could be included in the taxpayers’ payroll factors.

In disagreeing with the conclusions reached in the prior ALD decisions, the Tribunal found that the payroll factor regulation did not enlarge the language of the statute. The Tribunal noted that the ALD incorrectly relied on the definition of “compensation” found in a dictionary, rather than the definition found in the statute. In contrast, the statute defines “compensation” as “wages, salaries, commissions and any other form of remuneration paid to employees for personal services.”11 Not only did the payroll factor regulation restate the statutory definition verbatim, the Tribunal reasoned, but it also explicitly stated that payments made to independent contractors and other persons not classified as employees are excluded from the payroll factor.12 Finding that only amounts paid directly to employees are considered includable compensation for payroll factor purposes, the Tribunal refused to adopt the ALD’s rejection of the regulation in its prior cases.

FISM individuals are not taxpayer employees Finding the Alabama payroll factor regulation to be consistent with the statute, the Tribunal determined that the services provided to the taxpayers were performed by individuals who were not direct employees. The Tribunal noted that although the FISM employees were once employees of the taxpayers, they were no longer employees when the taxpayers were acquired by FIS. As the new employer of the individuals, FISM made changes to their roles and controlled all major decisions relating to their employment. The taxpayers did not pay the individuals directly because FISM issued paychecks to the individuals. Accordingly, the Tribunal concluded that the taxpayers did not have employees includible in the payroll factor of their Alabama apportionment factors during the tax years at issue. For these reasons, the Tribunal reversed the adjustments made by the Department.

Commentary The Tribunal’s decision holds significant relevance both from a procedural and substantive perspective. Procedurally, the Tribunal set the stage to break with the ALD decisions addressing the payroll factor by highlighting the importance of the Tribunal’s function as an independent agency. The Tribunal’s observation that it operates separately from the Department and is not bound by previous ALD decisions is a welcome development for taxpayers and their representatives that wish to appear in front of an impartial forum to resolve tax controversies prior to judicial proceedings. This observation also could resonate in other states and localities that have acted to create independent tax tribunals operating separately from their taxing authorities, in place of forums that historically may have been a division of the same executive agency.

As far as substantive relevance, the Tribunal confirmed that for the tax periods at issue, the Taxpayers did not have an Alabama payroll factor because FISM employed the individuals who historically worked for the Taxpayers prior to the FIS acquisitions. Based on this conclusion, businesses that make payments to affiliated or third-party service companies in exchange for personnel services should consider how they might be accounting for such arrangements for payroll factor purposes in states such as Alabama that still utilize a payroll factor in determining overall apportionment. These types of arrangements have become increasingly common for smaller to mid-size businesses that outsource services to management services companies or professional employer organizations.

Whether the Tribunal’s decision becomes final is contingent on the Department’s decision regarding a potential appeal of the matter to the Alabama circuit court. The Department has 30 days from the date of the June 12 order to appeal the decision.13



1 Complete Payment Recovery Services, Inc. et al. v. Alabama Department of Revenue, Nos. BIT. 17-583-LP, BIT. 17-751-LP, BIT. 17-572-LP, Alabama Tax Tribunal, June 22, 2020.
2 Following the allocation and apportionment provisions of the Multistate Tax Compact, Alabama employs a three-factor apportionment formula consisting of a property factor, payroll factor and a double-weighted sales factor. ALA. CODE § 40-21-1.
3 Mar-Jac Poultry AL LLC v. Alabama Department of Revenue, No. S. 16-253, Alabama Tax Tribunal, Aug. 10, 2016.
4 ALA. CODE § 40-2B-1 (emphasis in original).
5 ALA. CODE § 40-2B-2(a) (emphasis in original).
6 ALA. CODE § 40-2B-2(l)(7).
7 No. 00-288, Admin. Law Division, Alabama Department of Revenue, Feb. 9, 2001.
8 No. 05-948, Admin. Law Division, Alabama Department of Revenue, May 23, 2006.
9 FORMER ALA. ADMIN. CODE r. 810-27-1-4-.13(a)(3). The former regulation was repealed in 2016 and replaced by ALA. ADMIN. CODE r. 810-27-1-.13.
10 See ALA. CODE § 40-27-1.
11 ALA. CODE § 40-27-1 (emphasis in original).
12 FORMER ALA. ADMIN. CODE r. 810-27-1-4-.13(a)(3).
13 ALA. CODE § 40-2B-2(m)(2).



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