When apportioning net earnings for franchise and excise tax purposes, Tennessee continues to source gross receipts from sales of services to the state having the greatest proportion of a taxpayer's "costs of performance." However, Vodafone Americas Holdings, Inc. v. Roberts is the latest example of the wide latitude that the Tennessee Department of Revenue (Department) may possess to require service providers to use alternative apportionment methods under Tennessee's "variance" statute.
Vodafone Americas (Vodafone) was a 45 percent general partner in the Cellco Partnership (Cellco), a general partnership that operated the Verizon Wireless telecommunications network. Vodafone had no direct business activities in the United States other than the interest in Cellco. Cellco had gross receipts from wireless telephone customers, including customers with Tennessee billing addresses. In its original Tennessee Franchise, Excise Tax Returns (Returns), Vodafone sourced its gross receipts for Tennessee apportionment purposes based on customer billing addresses, not the costs of performance method required by Tennessee statute. Subsequently, Vodafone filed amended Returns seeking tax refunds based on costs of performance. The refund claims were denied by the Department, based on a variance issued requiring that sourcing of Vodafone's receipts be by billing address despite the costs of performance statute. Litigation thereafter ensued.
Chancery Court Decision
The Chancery Court first granted partial summary judgment in favor of the Department that Vodafone is doing business in and has nexus with Tennessee by virtue of its general partnership interest in Cellco. The Chancery Court ordered a trial on the variance issue.
On the variance issue, Vodafone's use of customer billing addresses as the sourcing method in its original Returns was similar, if not identical, to that required by the Commissioner's variance. For practical purposes, such similarity became the 900 pound gorilla in the room that Vodafone had to contend with while at the same time claiming a substantial tax refund using the statutory costs of performance method. The Chancery Court determined that the Department's variance was justified based on Vodafone's "tax history in Tennessee" together with the comparison that the costs of performance method reduced Vodafone's Tennessee receipts factor by 89 percent when compared to the receipts factor of the customer billing address method. The 89 percent sales factor disparity was viewed by the Court as "an unusual factual situation specific to Vodafone."
Are There Any Limits on the Department When Issuing a Variance to Require Alternative Apportionment?
In view of Vodafone Americas (and certain Tennessee Court of Appeal decisions), are there any limitations on the Department's issuance of variance letters imposing alternative apportionment formulas? Some comments on that question are as follows:
  1. Disparity in a single factor should not be sufficient to prove that the standard formula does not fairly reflect business activity in Tennessee. The comparison should be between the standard formula and alternative formula as a whole. U.S. Supreme Court and other state court decisions support formula comparisons, not factor comparisons. The factors are intended to balance each other and distortion in one factor does not mean the formula is distorted.
  2. The Chancery Court recognized in Vodafone Americas that the Commissioner has "narrow discretion" to issue a variance (presumably for "unusual factual situations"), yet then granted almost unlimited discretion in the choice of an alternative. One could certainly argue that such a determination runs counter to state tax uniformity.
  3. Arguably, an 89 percent disparity between receipts factors of different methods shows that the factors are 89 percent different, not that one formula better reflects business activity over another. It is unclear how the disparity used by the Department reflected the economic realities of the Cellco business conducted in Tennessee and elsewhere.
  4. Although the Chancery Court stated that the Department's variance did not "hinge on a showing" of "nowhere income," the Department played the "nowhere income" card through its expert witness. The greatest proportion of Vodafone's costs of performance (via Cellco) were in California, Georgia and New Jersey. Not only are the apportionment formulas of these states in general (and for telecommunications companies specifically) not uniform with each other, all three of these states' telecommunications apportionment rules are inconsistent with the method required by Tennessee. Given the presence of inconsistent laws and policies of the states in a case, the canard of "nowhere income" needs to be laid to rest.
  5. Will service-providers doing business in Tennessee be forced to raise constitutional arguments to the Department's variances? Conversely, can Tennessee-based service providers benefit from their "unusual factual situations" and Tennessee case law so as to seek variances for alternative methods that do not source their gross receipts using costs of performance?
These and similar comments need to be addressed in balancing the desire for state tax uniformity, on the one hand, with the right on the other hand to seek or demand a variance either for a specific factor or the entire formula. Courts would seem to be in the best position to strike that balance between the reality of different, even inconsistent, state tax systems imposed on taxpayers and the often elusive goal of state tax uniformity.