Florida DOR on Hedging: Mixed Bag or Safe Bet to Plan Future Transactions?

A Florida taxpayer was engaged in three types of hedging activity: (1) hedges on materials related to its inputs; (2) hedges related to the commodity it sells; and (3) hedges unrelated to items it purchases or sells. In deciding whether the hedging revenue was properly included in the taxpayer's sales factor, the Florida Department of Revenue (DOR) in TM 12C1-007 (the "Ruling") establishes a rule based on whether the transaction is a "true" or "actual" sale. The ruling concludes that gross receipts from the three hedging transactions were never included in the sales factor, and net receipts from hedges on input materials used by the taxpayer and commodities unrelated to the taxpayer's business are also excluded. However, net receipts from hedging on commodities the taxpayer sells in its business are considered "sales" and included in the sales factor because the taxpayer is engaged in the sale of the underlying commodity. [Florida Department of Revenue, Technical Assistance Advisement, No. 12C1-007 May 25, 2011)].

The taxpayer was part of a federal affiliated group and engaged in the following activities: 1) Selling a commodity produced by affiliates of the group; 2) Procuring input items used in the group's commodity production process; and 3) Managing the risk of price fluctuations in the commodity markets for the group. The taxpayer used financially-settled derivative instruments such as swaps, options, and futures contracts to lock in, or "hedge," pricing in order to manage the commodity price risk exposure.

For the input hedging, the DOR notes that the taxpayer's primary objective with its input hedging transactions is not to make a profit, but rather to hedge against the risk of price fluctuations inherent in the  commodities market. The taxpayer also participates in transactions for which there is no underlying commodity market price risk being hedged. These hedges are referred to as proprietary hedging. The taxpayer's reason for engaging in these trades is to keep its traders active in markets where it needs to hedge the price of commodities, to determine the spot price of the commodity, and to recognize trends in the commodity market. Based largely on these factors, the Ruling concluded that neither of these types of transactions constituted sales within the context of the sales factor, and therefore, the receipts (both gross and net) were not properly included in the sales factor.

The taxpayer also entered into hedges on the commodity that the taxpayer sells and produces at various facilities. The facilities do not enter into long-term sales contracts and therefore they are subject to commodity price fluctuations. To effectively manage the price risk associated with the sale of the commodity, taxpayer hedges against the future sale of the commodity. The taxpayer has a hedging strategy for each facility and determines the price it wants to receive from the future sales of the commodity produced by each facility. Unlike the input and proprietary hedging, the taxpayer accounted for the gains from its commodity hedging as income from operations.

Under Florida law, the numerator of the sales factor includes "the total sales of the taxpayer in this state" and the sales factor denominator as "the total sales of the taxpayer everywhere." Florida Rule 12C-1.0155(1) defines sales as "all gross receipts received by the taxpayer from transactions and activities in the regular course of its trade or business"(emphasis in the ruling). In deciding that the input and proprietary hedging were not "actual" sales, the Ruling cited two Florida court decisions for the proposition that certain intercompany sales may be excluded from the sales factor because such sales were not "actual sales." Coulter Electronics v. Department of Revenue, 365 So.2d 806 (Fla. 1st DCA 1978) and Department of Revenue v. Anheuser Busch, 527 So.2d 877 (Fla. 1st DCA 1988). The Ruling concluded that the taxpayer's hedging transactions were similarly not "actual sales" and therefore were excluded from the taxpayer's sales factor. While the Ruling made clear that it was not invoking its alternative apportionment powers under Fla. Stat. § 220.152, it stated that "[i]including such transactions would not fairly represent the group's business." The Ruling also stated that the accounting treatment of a transaction is a relevant consideration in deciding whether the income associated with such transactions may be apportioned.

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