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Multistate US tax issues for inbound companies: Part II - multistate apportionment

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Non-US entities may be familiar with the US federal tax concept of effectively connected income. That is, being taxed on income that is derived from a US business; however, for multistate tax purposes, a percentage of the entire net income of an entity (or group of entities, as discussed below) may be subject to tax by a state. That percentage generally relates to the proportionate level of activity the entity has with the state as compared with its activity outside the state.

Activity may be measured by the relative in-state sales, property, payroll, or any combination of the three. Some states give greater weight to sales activity than property and payroll. A current trend among states is a move to a single-sales weighted apportionment factor. A single-sales factor results in states increasing their taxable reach among out-of-state taxpayers because the absence of in-state property and payroll does not serve to dilute the apportionment percentage assigned to the state as it would for a state that incorporates a property or payroll factor.

Complexities arise as states do not uniformly apportion income. For example, the assignment of service income to a particular state may be treated in various ways. Some states source service income to the location where the provider incurs the greater cost in performing the service. Other states employ a marketplace approach, sourcing to where the customer receives the benefit of the service.

Sales of tangible personal property are generally sourced to the state of destination. One exception applies to the extent a state has a throwback rule. Under throwback, sales are sourced to the state of origin if the taxpayer does not have nexus with the destination state or country.

The potential combination of a state asserting nexus based merely on a company having a certain threshold level of sales in a state, along with a single-sales factor apportionment regime and US treaties not binding the state, could result in substantial state income tax liability for an inbound company.

Joel Walters, based in Washington, DC, is PwC's US Inbound Tax leader. Maureen Pechacek, based in Minneapolis, and Todd Roberts, based in Denver, are partners in the firm's State and Local Tax practice. The authors give special thanks to Michael Santoro.

This is the second in a series of articles looking at multistate US tax issues facing inbound companies. Part I looked at instances and activities that could subject a foreign entity to state tax. Look out for Part III next week.

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