Unfortunately, uncertainty is everywhere in the business world. From a financial management and reporting perspective, uncertainty is never a welcome environment. Predictability is the desired environment. Corporate management and business owners live and die (and often are compensated) by the financial performance of the business. But CFOs and their companies can play a role in reigning in the uncertainty in the state and local tax (SALT) world that can arise from states’ use of discretionary authority provisions.
One important element of the financial performance of a business is the effective tax rate. Management wants to know with some degree of predictability the impact taxes have on the company’s financial statements. Management also is interested in how the company’s effective tax rate stacks up against the effective tax rates of other businesses. Investors and analysts also look a company’s financial statements and desire some level of predictability. The widespread desire for predictability in financial reporting falls squarely on the desk of the CFO.
But when it comes to taxes, the CFO looks to the vice president of tax to help achieve desired levels of predictability. Everyone is happy when the actual impact of international, federal, state and local taxes is close to the predicted impact. Things get dicey, however, when the vice president of tax has to make the long walk down the hall to the CFO’s office to report a “tax issue” that could have an impact on the company’s financial reports.
Imagine this story, which although fictional, is based on real-life situations. Everywhere, Inc. operates on a multistate basis through various subsidiary entities. The Everywhere consolidated group sells products and services on a worldwide basis. As is often the case, there are many intercompany transactions among Everywhere and its affiliates.
Everywhere and its subsidiaries file a federal consolidated income tax return. In State A, the law requires that Everywhere and each of its subsidiaries with nexus in State A file separate corporate income tax returns. In State B, Everywhere and certain of its subsidiaries are required to file a state-level combined corporate income tax return. State B apportions income within and without the state based on a single sales factor, the numerator of which is gross receipts from sources in State B and the denominator of which is gross receipts from all sources.
State B provides that income from the performance of services is sourced to State B based on the cost-of- performance method, which assigns income from an income-producing activity to the state where a majority of the services are performed. Following the cost-of-performance method, Everywhere reports no service income to State B because the majority of the costs of performing the services are provided outside State B. Everywhere’s treasury department is responsible for Everywhere’s cash management system, including short-term investments of available funds. Everywhere’s State B return includes the gross receipts from the treasury department security transactions in the denominator, but not the numerator, of the State B sales factor.