96-2266

CORPORATE

Signed 1/27/97

BEFORE THE UTAH STATE TAX COMMISSION

____________________________________

COMPANY C. )

:

Petitioner, ) FINDINGS OF FACT,

: CONCLUSIONS OF LAW,

v. ) AND FINAL DECISION

:

AUDITING DIVISION OF THE ) Appeal No. 96-2266

UTAH STATE TAX COMMISSION, :

) Account No. ##### Respondent. :

) Tax Type: Corporate Franchise

_____________________________________

STATEMENT OF CASE

This matter came before the Utah State Tax Commission for a Formal Hearing on August 20, 1997. Richard B. McKeown, Commissioner, heard the matter for and on behalf of the Commission. Present and representing Petitioner was Petitioner's legal counsel, PETITIONERS REP.. Present and representing Respondent was RESPONDENT REP., Assistant Attorney General.

Based upon the evidence and testimony presented at the hearing, the Tax Commission hereby makes its:

FINDINGS OF FACT

1. The tax in question is Corporate Franchise tax.

2. The period in question is tax years 1992-1994.

3. COMPANY C (ACOMPANY C@ or APetitioner@) is a diversified holding company with subsidiaries qualified to do business in Utah during the tax years at issue in this appeal. COMPANY Z. (ACOMPANY Z@) was one of the wholly owned subsidiaries of COMPANY C that was qualified to do business in Utah in tax years 1992, 1993 and 1994.

4. COMPANY Z operated as a common carrier telecommunications company, selling or reselling long distance telephone access. COMPANY Z=s customers are located both in and outside of Utah.

5. COMPANY Z provided digital telecommunications services through a nationwide network of PRODUCT M and PRODUCT O, some of which was physically located in Utah. The fiberoptic cable, microwave equipment and other equipment that made up the network were owned or leased by COMPANY Z.

6. COMPANY Z employed approximately ##### employees in Utah for the purpose of maintaining COMPANY Z=s equipment and tangible personal property in Utah.

7. COMPANY Z operated as a unitary business with Petitioner. Petitioner filed Utah corporate franchise returns for each tax year in the audit period claiming income from Utah sales of $$$$$, $$$$$ and $$$$$ in each year respectively.

8. Petitioner later filed amended returns for tax years 1992 and 1993, contending that the income for COMPANY Z=s service provided to Utah customers should be apportioned to Utah based on the cost of performance formula set out in Utah Code Section 59-7-319(1)(a).

9. Respondent subsequently audited Petitioner and issued an audit report which found, in pertinent part, that the sales of service by COMPANY Z to Utah customers were Utah sales for purposes of calculating the sales factor of the UDITPA formula.

10. After the audit, Petitioner filed an amended return for tax year 1994, requesting a refund based on its position that its sales of service to Utah customers must be apportioned according to the cost of performance.

ISSUE

Is COMPANY Z entitled to use the cost of performance formula for the purpose of allocating income derived from its provision of XXXXX service in Utah?

APPLICABLE LAW

1. Utah Code Ann. Section 59-7-311 states:

All business income shall be apportioned to this state by multiplying the income by a fraction, the numerator of which is the property factor plus the payroll factor plus the sales factor, and the denominator of which is three.

2. Utah Code Ann. Section 59-7-317 states:

The sales factor is a fraction, the numerator of which is the total sales of the taxpayer in this state during the tax period, and the denominator of which is the total sales of the taxpayer everywhere during the tax period.

3. Utah Code Section 59-7-319 states, in pertinent part:

(1) Sales, other than sales of tangible personal property, are in this state if:

(a) the income-producing activity is performed in this state; or

(b) the income-producing activity is performed both in and outside this state and a greater proportion of the income-producing activity is performed in this state than in any other state, based on costs of performance.

4. Utah Administrative Rule R865-6F-8 states in pertinent part:

6. Sales Other than Sales of Tangible Personal Property in this State.

a) In general, Section 59‑7‑319(1) provides for the inclusion in the numerator of the sales factor of gross receipts from transactions other than sales of tangible personal property (including transactions with the United States government). Under Section 59‑7‑319(1), gross receipts are attributed to this state if the income producing activity that gave rise to the receipts is performed wholly within this state. Also, gross receipts are attributed to this state if, with respect to a particular item of income, the income producing activity is performed within and without this state but the greater proportion of the income producing activity is performed in this state, based on costs of performance.

b) The term "income producing activity" applies to each separate item of income and means the transactions and activity directly engaged in by the taxpayer in the regular course of its trade or business for the ultimate purpose of obtaining gains or profit. . . .

ANALYSIS

Utah=s UDITPA provisions are designed to pinpoint the amount of income earned by a multistate corporation that is attributable, and thus taxable, in Utah. The UDITPA provision that is at the heart of this controversy is the sales factor, which functions to allocate receipts from, among other things, the sale of property or services in this state. At issue is whether income derived by COMPANY Z from sales of XXXXX service in Utah is includable in the Utah sales factor.

COMPANY Z owns or leases access to PRODUCT M, PRODUCT O and other network or system equipment that is located in and outside of Utah. COMPANY Z receives income from selling access to its network to Utah corporate customers or reselling access to other telephone service providers. Without regard to COMPANY Z=s customers= physical location, their telephone transmissions may be routed through the lines or networks that are physically located both within and outside of Utah.

Petitioner characterizes COMPANY Z=s sales as Asales other than sales of tangible personal property,@ and argues that performance of its service takes place, for the most part, outside of Utah. On that basis, Petitioner contends that its income derived from sales by COMPANY Z of its services in Utah must be apportioned under Utah Code Section 59-7-319(1)(b), which attributes income on the basis of cost of performance.

In support of its position, Petitioner argues that COMPANY Z sells interstate SERVICE H to customers throughout the country and around the world. Its network system runs through most states, but the network is primarily operated from network centers in STATE 1 and STATE 2. Petitioner correctly points out that most of COMPANY Z=s costs associated with operating a world-wide SERVICE H network are incurred outside Utah. However, while the net costs of operating a worldwide network are relevant to determining the denominators of the property and payroll factors, they are irrelevant to the cost of performance ratio, which is used to determine whether receipts from an income producing activity in Utah should be included in the numerator of the Utah sales factor. When transactions other than sales of tangible personal property are performed both within and without this state, gross receipts are attributable to Utah, and thus includable in the numerator of the Utah sales factor, if Athe greater proportion of the income producing activity is performed in this state, based on the costs of performance.@ Utah Admin. Rule R865-6F-8(I)(6). AThe term >income producing activity= applies to each separate item of income . . . . Id. Every sales transaction, then, is considered a discreet transaction. The cost of performance ratio applied to each transaction is measured by the direct costs of that transaction incurred in Utah compared to the direct costs of that transaction incurred outside of Utah. If the greater proportion of costs are incurred in Utah, the receipts must be included in the numerator of the Utah sales factor.

Petitioner has not identified the actual direct costs associated with COMPANY Z=s transactions in Utah. Instead, it attempts to impute to Utah the common costs that COMPANY Z incurred in providing services to all of its customers across the country and throughout the world. Following Petitioner=s argument to its logical conclusion, COMPANY Z=s receipts cannot be attributed to any state=s sales factor because its costs of performance in each state are outweighed by the collective costs incurred in all of the other states (See Petitioner=s Opening Brief, Exhibit B.)

Although COMPANY Z has costs associated with maintaining a worldwide telephone network, these indirect costs are properly accounted for and weighted in the UDITPA property and payroll factors. Petitioner has not, and probably cannot, identify direct costs associated with providing service to its Utah customers.

If Petitioner cannot resort to the cost of performance formula set out in section 59-7-319(1)(b), it must calculate the sales factor in accordance with section 59-7-319(1)(a). Under subsection (1)(a), Petitioner=s receipts are allocable to Utah if it has Aincome-producing activity@ in Utah. We cannot agree with Petitioner that the income-producing activity at issue in this case is the transmission of a signal from or through Petitioner=s central office outside of Utah. Petitioner provides telephone service to customers that are physically located in Utah or access to equipment that is physically located in Utah.

Therefore, we reject Petitioner=s theory and methodology, and we deny Petitioner=s claim for refund.

DECISION AND ORDER

Based on the foregoing, the Commission finds that COMPANY Z'S receipts from sales in Utah must be included in the numerator of the sales factor of the UDITPA formula as provided in this opinion. It is so ordered.

DATED this 27 day of January, 1997.

BY ORDER OF THE UTAH STATE TAX COMMISSION.

W. Val Oveson Richard B. McKeown

Chairman Commissioner

Joe B. Pacheco Pam Hendrickson

Commissioner Commissioner

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