I.  INTRODUCTION
 

In Commissioner of Revenue v. AT&T Corporation, 82 Mass. App. Ct. 1106; 2012 Mass. App. Unpub. LEXIS 889 (Mass. App. Ct. July 13, 2012) (“AT&T”), the Massachusetts Appeals Court (the “Court”) upheld a decision of the Appellate Tax Board (the “ATB”) in favor of AT&T Corporation (the “Taxpayer”).[1]  The primary issue in the case was whether telephone calls that were originated by Massachusetts customers but terminated outside of Massachusetts resulted in “sales in the commonwealth” for purposes of calculating the sales factor in the income apportionment formula that is used to determine the share of the Taxpayer’s net income subject to corporate excise tax in Massachusetts.  This technical information release will briefly describe the decision in AT&T and the facts and circumstances that underlie the decision, and the implications of that case for other taxpayers and cases. 
 

II.  LEGAL BACKGROUND
 

Under General Laws chapter 63, section 38, a corporation is taxed annually on its net income “derived from business carried on within the commonwealth.”  When a corporation does business both within and without Massachusetts, its Massachusetts taxable income is generally computed by apportioning its total net income with reference to three discrete “factors”: its payroll factor, its property factor, and its sales factor.  The first two factors seek to assess the corporation’s physical footprint in Massachusetts by measuring its in-state payroll and tangible property.  The sales factor measures a corporation’s in-state sales.  Sales of tangible personal property are generally sourced to Massachusetts where “the property is delivered or shipped to a purchaser within the commonwealth regardless of the f.o.b. point or other conditions of sale.”  G.L. c. 63, § 38(f).[2]  A corporation’s receipts from sales “other than sales of tangible personal property” are generally sourced based on the location of the income-producing activity that generated the sales.  Pursuant to General Laws chapter 63, section 38(f), if all the income-producing activity is in Massachusetts, such sales are sourced to Massachusetts.  If, on the other hand, the relevant income-producing activity is performed both in and outside Massachusetts, the sales will be sourced to Massachusetts only if a greater proportion of the income-producing activity is performed in Massachusetts than in any other state, based on costs of performance.[3] 
 

The Department has promulgated detailed regulations with respect to corporate apportionment that “elaborate further the meaning and proper application of [General Laws chapter 63, section 38(f)].”  Boston Professional Hockey Association, Inc. v. Commissioner (“BPHA”), 443 Mass. 276, 281 (2005).  Those regulations provide guidance with respect to identifying the relevant income-producing activity, defined as “a transaction, procedure, or operation… which results in a separately identifiable item of income.”  830 C.M.R. 63.38.1(9)(d)(2).  “In general, any activity whose performance creates an obligation of a particular customer to pay a specific consideration to the taxpayer is an income-producing activity.”  Id.[4]  See also BPHA, 443 Mass. at 282 (noting that the Department’s “regulations establish specific rules for use in determining when gross receipts arising from different types of ‘income-producing activities’ (occurring within and outside the Commonwealth) are properly apportioned to Massachusetts”). 
 

Consistent with the Department’s regulations, Massachusetts courts have determined that either a “transaction” or “operation” on the part of a taxpayer can result in a separately identifiable item of income.  For example, in The Interface Group v. Commissioner, the Appeals Court commented on the Supreme Judicial Court’s holding in BPHA, which upheld the Department’s use of the operational approach, not the transactional approach, with respect to certain types of sales.  72 Mass. Ct. App. 32 (2008).  However, the Appeals Court in Interface noted that, despite that particular holding in BPHA, BPHA “clearly indicates that the application of the regulation depend[s] on the facts in issue, and … does not stand for the proposition that a corporation's overall operation is, ipso facto, its ‘income-producing activity.’”  Id. at 40. 
 

III.  THE AT&T DECISION
 

At all times relevant in the AT&T case, the Taxpayer was a New York corporation headquartered in New Jersey, and was in the business of providing interstate and international network telecommunications services.  Following an audit, the Taxpayer filed an Application for Abatement of its corporate excise tax for the years 1996-1999, seeking to exclude from the numerator of its sales factor its receipts from telephone calls that originated in Massachusetts but terminated elsewhere.[5]  Because the parties agreed that the relevant income-producing activity was not solely in Massachusetts, the case focused on whether a greater proportion of the income-producing activity was performed in Massachusetts than in any other state, based on costs of performance. 
 

For purposes of determining the applicable income-producing activity, the Department argued for a transactional approach under 830 C.M.R. 63.38.1(9)(d)(2), contending that the relevant income-producing activity was the sale of individual long-distance telephone calls and the services necessary to transmit each call.  The ATB, however, agreed with the Taxpayer that the operational approach was more appropriate for application to the Taxpayer’s facts and circumstances, concluding that the relevant income-producing activity was the operation and maintenance of a global network.  In support of its argument for an operational approach, the Taxpayer asserted the complexity of tracking the location of services provided with respect to each interstate phone call, and contended that it would be “arduous, if not impossible” to determine the Taxpayer’s direct costs at the level of each individual transmission.  AT&T Corp. v. Commissioner of Revenue, A.T.B. Docket No. C293831 (2011).
 

The Appeals Court affirmed the ATB’s decision, noting in part the Board’s finding that “it would be nearly impossible to use a transaction-based analysis because of the complexity of tracing the long-distance telephone calls in question.” AT&T at *5.  However, the Court reiterated (quoting its decision in Interface) that “'the application of the [Department’s] regulation depend[s] on the facts in issue' and that application of an operational approach is not guaranteed.” Id.
 

IV.  CONCLUSION
 

AT&T represents a determination as to the application of the sales factor rules pertaining to sales of “other than tangible personal property” in the context of one specific fact pattern.  Other cases and fact patterns may call for a different analysis.  First, in other circumstances, in contrast to AT&T, it may be the case that the relevant income-producing activity is entirely within or without Massachusetts, thus eliminating the need for any cost of performance analysis.  See G.L. c. 63, § 38(f).  Second, even where, as in AT&T, a taxpayer engages in income-producing activity both within and without Massachusetts, in many circumstances the Department’s regulations will call for the use of a transactional approach, rather than the operational approach that was applied to the facts as presented in AT&T.  In general, the appropriateness of the transactional approach will depend on the nature of a taxpayer’s activity the performance of which creates an obligation of a particular customer to pay a specific consideration.  As noted above, AT&T represented a case where the transactional approach was determined, in the particular facts and circumstances presented by the taxpayer, not to be appropriate as applied to the taxpayer’s activity of operating a nationwide telecommunications network.

 

/s/Amy Pitter
Amy Pitter
Commissioner of Revenue

 

AP:MTF

August 20, 2013

TIR 13-12



[1] The Court’s decision was a Rule 1:28 decision, which may be cited for its persuasive value but is not binding as precedent.  The Commissioner subsequently requested further appellate review by the Supreme Judicial Court; such further review was denied.
[2] A special “throwback” rule may also apply, sourcing such sales to Massachusetts in circumstances where the corporation “is not taxable in the state of the purchaser and the property was not sold by an agent or agencies chiefly situated at, connected with or sent out from premises for the transaction of business owned or rented by the corporation outside the commonwealth.”  Id.
[3] The statutory rules for sourcing these sales have been changed for taxable years beginning on or after January 1, 2014.  Per the new statute, the basic principle is that “sales, other than sales of tangible personal property, are in the commonwealth if the corporation's market for the sale is in the commonwealth. “  See St. 2013, c. 46, §§ 37, 84.  The new statutory provisions contain further details on applying that principle in a variety of contexts (including sales of services).
[4] In the 2009 case, The Interface Group v. Commissioner of Revenue, the Appeals Court in a Rule 1:28 decision affirmed the decision on remand of the Appellate Tax Board in which “the board upheld the commissioner's use of the ‘operational’ approach, finding that Interface's income-producing activity was the assembly of travel packages and not the individual sales of those packages.”  2009 Mass. App. Unpub. LEXIS 1264 (2009).  In reaching its conclusion, the Appeals Court noted that “[The board] affirmed this approach because the [DOR’s] regulations place an emphasis on the ‘direct activity by the taxpayer,’ and Interface did not sell travel packages directly to customers.”  Id.  See the next paragraph in the text for reference to the prior 2008 decision of the Appeals Court in this same Interface litigation.
[5] The sales factor rules that applied to the Taxpayer for the years in question were the general rules that apply to business corporations and utility corporations subject to tax under chapter 63.  See G.L. c.63, §§ 38, 52A.  However, subsequent to the tax years at issue in AT&T and as authorized by G.L. c. 63, § 38(j), the Department promulgated an industry-specific alternative apportionment regulation that applies to corporations engaged in the sale of telecommunications services for taxable years beginning on or after January 1, 2009.  See 830 CMR 63.18.11; G.L. c. 63, § 38(j).  Pursuant to that regulation, “gross receipts from the sale of telecommunications services … which are sold on a call-by-call basis are in this state [i.e., Massachusetts] when (a) the call originates and terminates in this state or (b) the call either originates or terminates and the service address is also located in this state.” 830 CMR 63.38.11(5).