The South Carolina Department of Revenue (“Department”) appealed the South Carolina Court of Appeal’s decision in Rent-A-Center West, Inc. v. South Carolina Dep’t of Revenue on November 30, 2016. The Court of Appeals held, on October 26, 2016, that the Department did not satisfy its burden to apply alternative apportionment to Rent-A-Center West, Inc. (“RAC West”). The Court of Appeal’s decision is a big win for taxpayers in South Carolina as it reaffirms that the Department cannot rely on bald assertions to apply alternative apportionment.
The taxpayer, RAC West, is a subsidiary of Rent-A-Center Inc., a rent-to-own business. RAC West owns and operates retail stores in western states, in addition to owning and licensing Rent-A-Center’s intellectual property (e.g., trademarks, trade names, etc.). RAC West licensed its intellectual property to an affiliate, Rent-A-Center East Inc. (“RAC East”), that owns and operates retail stores in eastern states, including South Carolina. RAC West had no other activities in South Carolina aside from licensing the intellectual property to RAC East for use in the state.
The Department argued that South Carolina’s standard apportionment formula did not properly represent RAC West’s business activity in the state and proposed to exclude RAC West’s retail sales from the denominator of its single-gross receipts factor apportionment formula, thereby increasing its South Carolina apportionment percentage. RAC West did not have any retail sales in the numerator of its South Carolina apportionment formula because it did not operate any retail stores in South Carolina. The Department’s expert witness stated that, because RAC West did not have any retail sales in its South Carolina numerator, the standard formula was “putting apples in the numerator and apples and oranges in the denominator.” He further testified that the Department’s method was reasonable and that excluding RAC West’s retail sales was essential “to come up with a tax burden that fairly represented the economic nexus of the entity with South Carolina.”
RAC West countered the Department’s argument by demonstrating that “there is a unitary relationship between the business activities of the retail stores in the western states and the licensing of intellectual property in other states.” RAC West argued that separating the receipts from the two activities would result in an inaccurate measure of RAC West’s activities in South Carolina because of the inextricable link and synergy between the value of the intellectual property and the profitability of RAC West’s retail business. Further, RAC West’s expert explained that “the standard apportionment worked the way it was supposed to in this case.”
The court held that the Department did not satisfy its burden to prove that South Carolina’s statutory apportionment formula did not fairly represent RAC West’s business activities in the state. The court stated that the Department presented the same level of evidence as it did in CarMax Auto Superstores West Coast, Inc. v. South Carolina Dep’t of Revenue, where the South Carolina Supreme Court held that the Department failed to meet its burden of proof. The court further noted that the auditor did not point to any specific evidence in making its argument that the standard apportionment formula did not fairly represent RAC West’s activity in the state.
As state revenue departments around the country are increasingly seeking to rely on alternative apportionment when making audit adjustments, this case highlights the heavy burden that state revenue departments must meet when asserting alternative apportionment. Taxpayers in South Carolina (as well as in other states with similar alternative apportionment authority) should vigorously object to unsupported assertions by state revenue departments that the statutory formula does not fairly represent the taxpayer’s business activity in the state, pointing to this case, among others, for support. Based upon the Department’s decision to appeal for a rehearing, it is clear that the Department is looking to aggressively pursue this issue. If the Department is unsuccessful in its rehearing, it could then petition to the South Carolina Supreme Court.