Alabama Adopts Double-Weighted Sales Factor and Market Based Sourcing

As states continue to search for the "best" (i.e. produces the most tax revenues) corporate tax system for our evolving economy, Alabama has joined the quest by adopting a double-weighted sales factor and moving to a market based sourcing rule. H.B. 434 was enacted on June 9, 2011, and applies to tax years beginning on or after December 31, 2010. Alabama previously utilized a more traditional equally weighted, three-factor apportionment method. Sales, other than sales of tangible personal property, were sourced to Alabama only:

• If the income producing activity occurred in Alabama; or
• if activity sourced both inside and outside of Alabama, then to Alabama only if the proportion in Alabama was greater than that proportion outside.

 In other words, Alabama followed what is commonly referred to as the cost-of-performance method.

Under the recently enacted legislation, Alabama utilizes a double-weighted sales factor and adopts market-based sourcing rules for sales of other than tangible personal property. The new Alabama rules are modeled on the work of the Multistate Tax Commission in rewriting the provisions of section 17 of the Multistate Tax Compact. Under these rules, a taxpayer's market is Alabama when:

• In the case of a sale of a service, if and to the extent that the service is delivered to a location in Alabama;
• In the case of a lease or license of intangible property, or sale or exchange of intangible property, if the receipts from the transaction derive from payments that are contingent on the productivity, use or disposition of the property, if and to the extent that property is used in the state - provided that property used in marketing a good or service to a consumer is used in the state if the good or service that is marketed using the intangible property is purchased by a consumer in the state; and
• In the case of the sale of intangible property that is a contract right, government license, or similar intangible property, that authorizes the holder to conduct a business activity in a specific geographic area, if and to the extent the intangible property is used in or otherwise associated with the state.

If the proper state for assignment of a sale cannot be determined by these rules, then the statute prescribes that such assignment shall be made by any reasonable approximation. For sales or leases/licenses of real property, the statute provides that the market is Alabama if, in the case of:

• A sale, lease, license, or rental of real property, the property is located in Alabama; or
• A sale, lease, license, or rental of tangible personal property, the property is located in Alabama.

For taxpayers not taxable in the state of assignment, or if no assignment can be made, then such sale is to be thrown out for sales factor purposes.

While the states utilizing such a market based system are still the minority, they are growing in number, which further evidences the ongoing struggle of states' tax systems to keep up. Tax practitioners must be vigilant to insure that their clients are well informed and instructed on how to comply with these new rules, and should take these changes as an opportunity to review tax structures and determine if a planning opportunity might exist.

RELATED LINKS: For further insight into state corporate income tax appotionment and related issues, see:

• 1-3 Bender's State Taxation: Principles and Practice § 3.10 - Apportion Rules for Business Income

• 1-3 Bender's State Taxation: Principles and Practice § 3.11 - Apportionment Formula

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