When a company ships everything into Alabama from out of state and makes few Alabama sales, does the corporate income tax 'throwback rule' overstate its Alabama sales factor — and can it apportion on a destination basis instead? And how is it classified for franchise tax?

Plain-English summary

Company A, a corporation based in "State Y" and doing business in States Y and Z, designs, contracts to manufacture, distributes, and markets a range of products. It warehouses and ships all its merchandise from State Y to retail department stores across the U.S., and makes its department- and specialty-store sales through showrooms in State Z. It recently bought a distribution facility in Alabama. It asked two questions.

Issue 1 — the "throwback rule." Alabama apportions a multistate corporation's income partly by a sales factor. Under the throwback rule (Corporate Income Tax Reg. 810-3-31.02(5)(c)(9)(vii)), if a company isn't taxable in the buyer's state, a sale is "thrown back" and attributed to Alabama when the goods are shipped from an Alabama office, warehouse, factory, or storage place. Company A worried that, with a new Alabama distribution center shipping goods nationwide, the throwback rule would artificially inflate its Alabama sales factor. Its own study estimated the Alabama sales factor at about 1.7% on a destination basis but 13.6%–35% under throwback, which would push the overall apportionment factor well above what its real Alabama activity warranted.

Alabama has a relief valve: Reg. 810-3-31.02(6) lets a taxpayer petition (or the Commissioner require) an alternative — separate accounting, excluding a factor, adding a factor, or any other method — when the standard apportionment "does not fairly represent the extent of a taxpayer's business in this State." The Department agreed that, assuming Company A's projections hold, the throwback rule would distort the overall apportionment factor, so it authorized Company A to report its sales for apportionment on a destination basis, excluding the throwback rule.

Issue 2 — franchise tax classification. Alabama's Franchise Tax Emergency Reg. 810-2-3-.12ER classifies foreign corporations as (1) manufacturing, (2) selling, (3) contracting, (4) transportation, (5) services, or (6) rentals/leasing. The Department said Company A would be classified as a "manufacturer" — not "selling" — under Reg. 810-2-3-.12ER(1)(d)1. if 50% or more of the items it sells are manufactured, processed, or fabricated by it. A manufacturer's Alabama franchise tax base is figured by averaging four allocation factors (cost of manufacturing/processing/fabricating; sales by destination; salaries/wages/commissions; and tangible property at original cost plus inventories), divided by three. Classification is an annual determination.

Holding: (1) the throwback rule would distort Company A's overall apportionment factor, so it is authorized to report sales on a destination basis; and (2) for franchise tax, Company A is a "manufacturer" if at least 50% of what it sells is manufactured/processed/fabricated by it — determined each year.

What this means for you

Alabama's throwback rule has an escape hatch when it distorts

If shipping goods out of an Alabama location throws too many sales back into your Alabama sales factor and overstates your real Alabama presence, Reg. 810-3-31.02(6) allows alternative apportionment — here, a destination-basis sales factor. Expect to prove the distortion with a study comparing the standard and alternative factors, as Company A did.

Alternative apportionment is fact-specific and must be justified

The Department granted relief based on Company A's own projections and reserved that it holds "assuming the projections actually materialize." Alternative apportionment is not automatic — you (or the Commissioner) must show the standard method doesn't fairly represent your Alabama business.

Franchise-tax "manufacturer vs. seller" turns on a 50% test — every year

Whether you're taxed as a manufacturer or a seller for Alabama franchise tax depends on whether ≥50% of the items you sell are made/processed/fabricated by you (Reg. 810-2-3-.12ER(1)(d)1.), and it's redetermined annually — so a change in your product mix can change your classification and the factors used.

Not precedent

Under § 40-2A-5 this ruling is not precedent and binds the Department only as to Company A's facts and projections. Your apportionment and classification need their own analysis. (This ruling applied Alabama's regulations and franchise tax as they stood in 1993; Alabama's franchise tax has since been restructured — confirm current law.)

Common questions

Q: What is Alabama's throwback rule?
A: Under Corporate Income Tax Reg. 810-3-31.02(5)(c)(9)(vii), a sale is attributed to Alabama (thrown back into the Alabama sales factor) when the seller isn't taxable in the buyer's state and the goods are shipped from an Alabama office, warehouse, factory, or storage location.

Q: Can I avoid the throwback rule if it overstates my Alabama activity?
A: Possibly. Reg. 810-3-31.02(6) allows alternative apportionment (including a destination-basis sales factor) when standard apportionment doesn't fairly represent your Alabama business. In this ruling the Department allowed exactly that, based on the taxpayer's distortion study.

Q: Am I a "manufacturer" or a "seller" for Alabama franchise tax?
A: Under Franchise Tax Emergency Reg. 810-2-3-.12ER(1)(d)1., you're a manufacturer if 50% or more of the items you sell are manufactured, processed, or fabricated by you. The classification is redetermined annually.

Q: Can I rely on this ruling?
A: No. Ala. Code § 40-2A-5 makes revenue rulings non-precedential; this one is limited to Company A's facts.

Citations and references

Regulations and code:

• Alabama Corporate Income Tax Regulation 810-3-31.02(5)(c)(9)(vii) — the throwback rule for the sales factor
• Alabama Corporate Income Tax Regulation 810-3-31.02(6) — relief when apportionment does not fairly represent the taxpayer's business in Alabama
• Alabama Franchise Tax Emergency Regulation 810-2-3-.12ER, including (1)(d)1. — classification of foreign corporations; manufacturer test and factor averaging
• Ala. Code 1975 § 40-2A-5 — revenue rulings are not to be used or cited as precedent

Source

• Landing page: Alabama Department of Revenue -- Revenue Rulings
• Original PDF: https://www.revenue.alabama.gov/wp-content/uploads/2022/06/2017_05_RR-93-001.pdf

Original ruling text

State of Alabama
Department of Revenue

Montgomery, Alabama 36132 GEORGE E. MINGLEDORFF Il

Assistant Commissioner

GEORGE E. MINGLEDORFF Hil LEWIS A. EASTERLY

ommissioner (Acting Secretary
° mes ALABAMA DEPARTMENT OF REVENUE
REVENUE RULING 93-001

This document may not be used or cited as precedent. Code of
Alabama 1975, 840-2A-5(a). ,

TO:

FROM: Commissioner of Revenue
Alabama Department of Revenue

DATE: February 12, 1993

SUBJECT: C1) Exception to the "Throwback Rule™ For
Corporate Income Tax and

(2) Proper Franchise Tax Classification

ISSUES AND FACTS

Company A is a State Y corporation doing business in State Y
and State Z. Company A's headquarters are located in State Y.
Company A designs, contracts for the manufacture of, distributes
and markets an extensive range of Product X. Currently, all of
the merchandise is warehoused and shipped from State Y to retail
department stores throughout the United States. Sales to
Company A's department and special store customers are made
through showrooms in State Z. Company A has recently purchased
a distribution facility in the State of Alabama. This facility
will support the continued growth of Company A.

C1) Whether the "throwback rule™ distorts income of Company
A attributable to Alabama by artificially inflating the sales

apportionment factor.

(2) Whether the franchise tax classification of Company A
as employing capital in Alabama primarily in selling is the
appropriate classification under the circumstances described.

LAW AND ANALYSIS

ISSUE (1)

Alabama Corporate Income Tax Regulation
§810-3-31.02(5)(c) (9) (vii) provides, “If a taxpaver is not
taxable in the state of the purchaser, the sale is attributable
to this state if the property is shipped from an office,
warehouse, factory or other. place of storage in this state."
This is the . “throwback rule." Regulation 810-3-31.02(6)
contains an exception to the "throwback rule"™. Regulation
810-3-31.02(6) provides, "If the allocation and apportionment
provisions of this regulation do not fairly represent the extent
of a taxpayer's business in this State, the taxpayer may
petition for or the Commissioner may require, in respect to all
or a part of the taxpayer's business activity, if reasonable:

Ca) Separate accounting;

Cb) The exclusion of one or more of the factors;

Cc) The inclusion of one or more additional factors which
will fairly represent the taxpayer's business activity in the
State; or

(d) The employment. of any other method to effectuate an
equitable allocation and apportionment of a taxpayer's income.

Company A conducted a study and provided the Alabama
Department of Revenue with the following information comparing a

sales apportionment factor using sales by destination and a

sales apportionment factor using the "throwback rule." Company
A provided the following table as its best estimate of what its
apportionment factors would be. Company A provided a range for

the "throwback rule™.

DESTINATION BASIS THROWBACK RULE

Low HIGH
SALES APPORTIONMENT FACTOR
Initial Year 1.7% 13.6% 35%
Third year 1.7% 13.6% 35%
OVERALL APPORTIONMENT FACTOR
Initial Year 12.6% 16.5% 23.7%
Third year 22.5% 26.5% 33.6%

Based on this study by Company A~— and assuming the
projections actually materialize, the "throwback rule™ would
distort the overall apportionment factor, because the sales
factor would not reflect Company A's true activity in the State
of Alabama. Based upon this information, Company A_ is
authorized to report its sales for sales apportionment purposes
on a destination basis, exclusive of the “throwback rule". This
change properly reflects its tax liability to Alabama.

ISSUE (2)

Alabama Franchise Tax Emergency Regulation 810-2-3-.12ER
enumerates the classification of foreign corporations doing
business in Alabama as either (1) manufacturing, (2) selling,
(3) contracting, (4) transportation, (5) services or

(6) rentals and/or leasing. For Alabama franchise tax

purposes, Company A would be classified as a “"manufacturer"™

assuming 50% or more of the items sold by Company A_ are

manufactured, processed or fabricated by Company A. Emergency

Regulation 810-2-3-.12ERC1)(d)1. Classification for franchise
tax purposes is an annual determination. Taxpayers employing
capital primarily in manufacturing, processing, or fabricating
are to determine their Alabama franchise tax Jliability as
follows: use the average of the Alabama percentages determined
by averaging the "cost of manufacturing, processing or
fabricating" allocation factor and the "sales by destination"
allocation factor, the “total salaries, wages, and/or salesmen,
brokers or agents commissions" allocation factor and_ the
"tangible property (Coriginal cost) and inventories" allocation
factor. To determine the Alabama allocation factor taxpayers

divide the sum of the allocation factors by three (3). See

id.
HOLDING

Based on the projection presented by Company A, the
Department agrees that the use of the "throwback rule™ would
distort the overall apportionment factor, because ‘the sales
factor would not reflect Company A's true activity in the State
of Alabama. The Department concurs that this would result in an
improper representation of income earned in Alabama, and
therefore, authorizes Company A to report its sales on a
destination basis as requested. |

For Alabama franchise tax purposes, Company A would be

classified as a "manufacturer™ assuming 50% or more of the

items sold by Company A are manufactured, processed, or

fabricated by Company A. Classification for franchise tax

purposes is an annual determination.

STAN MCDONALD
Commissioner of Revenue

BA: eb147