Can a company use separate accounting instead of Colorado's single-sales-factor formula to apportion its income—and what does it have to prove?

Plain-English summary

A company that supplies machinery to the corrugated-board industry asked the Department for permission to use separate accounting instead of Colorado's single-sales-factor formula, arguing the standard formula distorted its Colorado income and that separate accounting better reflected economic reality (and would show a Colorado loss). The Department denied the request.

Why the Department said no:

• Separate accounting was abandoned long ago. Colorado, like most states, dropped separate accounting because of the difficulties it creates. All apportionment formulas are approximations, so some distortion is expected and isn't, by itself, a reason to depart.
• It conflicts with Colorado's chosen method. In 2010 Colorado adopted the single-sales-factor method, which emphasizes where sales are made. Separate accounting instead emphasizes where costs are incurred — at odds with the legislature's approach.
• It's administratively overwhelming. Reviewing a company's full separate-accounting books is exactly what standardized formulas were meant to avoid.
• It can let income escape tax entirely. The company would likely apportion a substantial share of income to Colorado under the standard formulas it uses in other states, yet report no Colorado income here under separate accounting — so income could go untaxed by any state. The Department therefore generally requires a company using a non-standard method in Colorado to use the same method in every other state where it files (Rule 39-22-303.5.4(a)(6)(c)).
• The company didn't meet its burden. Although § 39-22-303.5(7)(b)(I) authorizes separate accounting in appropriate cases, the petitioner gave only conclusory information — e.g., describing its business as merely "supplying machinery to the corrugated board industry" — without the detailed breakdown of activities, revenues, and costs (and how each was assigned) needed for the Department to evaluate the petition independently.

The lesson: alternative apportionment is available but rare, and the burden is on the taxpayer to prove with detailed facts that the standard formula is unfair. This is the counterpoint to rulings where the Department granted a departure on a well-documented record, like [[plr-17-009-treatment-of-gain-realized-from-the-sale-of-ownership-interest-in-an-l]] and [[plr-16-015-acquisition-and-restructuring-transaction]]. As a GIL, it's general guidance only.

What this means for you

Companies considering a departure from the standard formula

Wanting a lower Colorado number isn't enough — and "the formula distorts my income" is a conclusion, not proof. To get alternative apportionment you must document, in detail: how and where you make sales, your operations by state, and your revenues and costs with an explanation of how each was assigned. Be ready to commit to using the same method in every state.

Multistate taxpayers tempted by "Colorado loss" positions

If your other-state returns apportion lots of income to Colorado but your Colorado return would show a loss under a special method, expect the Department to balk — that pattern signals income escaping tax everywhere, which it actively guards against.

Accountants and tax professionals

The authority is § 39-22-303.5(7)(b)(I), but the burden of proof and persuasion is heavy and detailed. Separate accounting in particular runs against the single-sales-factor policy. Note Rule 39-22-303.5.4(a)(6)(c)'s consistency requirement across states, and that these petition responses are published (redacted) under § 39-22-303.5(7)(d).

Common questions

Q: Can I use separate accounting instead of Colorado's single-sales-factor formula? A: Only in rare, well-documented cases. The Department denied it here, and it disfavors separate accounting as inconsistent with the single-sales-factor method.

Q: Why was the request denied?
A: The company gave only conclusory information and didn't carry its heavy burden of proving, with detailed facts, that the standard formula is unfair.

Q: Do I have to use the same alternative method in other states? A: Generally yes. The Department requires consistency to prevent income from escaping tax in every state.

Q: Can another taxpayer rely on this letter?
A: No. It's a General Information Letter — general guidance only, not binding on the Department, and not usable by other taxpayers.

Citations and references

Statutes and rules:

• § 39-22-303.5, C.R.S. (single-sales-factor apportionment, adopted 2010)
• § 39-22-303.5(7)(b)(I), C.R.S. (Department may approve separate accounting in appropriate cases)
• § 39-22-303.5(7)(d), C.R.S.; § 24-35-103.5, C.R.S. (publication of responses)
• 1 CCR 201-2, Rule 39-22-303.5.4(a)(6)(c) (same method in every state)
• 1 CCR 201-1, Rule 24-35-103.5 (GIL/PLR procedure)

Source

• Landing page: https://tax.colorado.gov/all-letter-rulings
• Original PDF: https://tax.colorado.gov/sites/tax/files/documents/GIL-14-017.pdf

Original ruling text

Office of Tax Policy
P.O. Box 17087
Denver, CO 80217-0087
[email protected]

GIL-14-017
June 24, 2014
XXXXXXXXXXXXXXXXXX
Attn: XXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXX
Re: Alternative Apportionment
Dear XXXXXXXXXXXX,
You submitted on behalf of XXXXXXXXXXXXXXX (“Company”) a request for special apportionment of Colorado income tax. Company seeks the Department’s permission to use separate accounting to determine what, if any, taxable income should be apportioned to Colorado. Company asserts that the single sales factor apportionment methodology distorts the income apportioned to Colorado and that separate accounting more fairly reflects the economic reality of Company’s income derived from Colorado sources. The Department has reviewed this request and, for the reasons set forth below, the Department does not grant Company permission to use separate accounting. We begin by noting that Colorado, as most other states, long ago abandoned separate accounting as a viable method for allocating income between and among states because of the many difficulties associated with that methodology. Moreover, all apportionment methodologies are approximations of the economic realities and, as such, some measure of distortion is to be expected. We also note that separate accounting is, at some level, inconsistent with the apportionment principles adopted by the Colorado General Assembly. Colorado for a number of years used a two and three factor apportionment methodology that apportioned income based, in large part, on where costs were incurred to generate that revenue. In 2010, Colorado adopted the single sales factor apportionment methodology that places a greater emphasis, particularly with respect to the sales of goods, on apportioning income where the sales are derived rather than where the costs are incurred. In contrast, the separate accounting method places greater emphasis on assigning costs to the jurisdiction where the sale was made. Thus, separate accounting strikes us as at odds with the underlying principles adopted by the legislature. Finally, states moved away from separate accounting and adopted standardized apportionment methodologies because it is administratively overwhelming to engage in a full review of the separate accounting for companies. For these reasons, alternative apportionment based on separate accounting is sparingly used. Nevertheless, the Department is authorized to approve separate accounting under appropriate circumstances.1

1

§39-22-303.5(7)(b)(I), C.R.S.

In our letter of April 10, 2014, we indicated that Company’s request to use separate accounting lacked the level of detailed information necessary for the Department to evaluate the request. Indeed, the letter simply stated, in conclusory fashion, that the single sales factor apportionment formula distorts income and that separate accounting more accurately reflects income derived in Colorado. More specifically, we stated that the request was insufficient because such a review requires “detailed” information regarding a whole host of issues, including the nature and extent of the Company’s business activities inside and outside Colorado and of its revenues and costs within and outside Colorado. The letter lacked details of the accounting that would allow the Department to independently determine whether separate accounting fairly apportions revenues and costs to Company’s activities in Colorado and in other states. Company submitted additional information by letter dated May 13, 2014. Again, the information provided lacks the detail that would allow us to independently evaluate whether separate accounting is proper. For example, in response to our request for a detailed description of its business activities within and outside Colorado, Company simply states that it is, “in the business of supplying machinery to the corrugated board industry.” This does not constitute a detailed description of its business activities inside and outside Colorado. A detailed description includes, among other things: how sales are solicited and consummated; what company’s ongoing relations with entities or persons in Colorado are and in the other states; where are a company’s operations; etc. Company also does not provide any meaningful information with respect to revenues and costs inside and outside Colorado or explanations of how and why cost components and revenues were apportioned or allocated. Company provided a statement setting forth the sales price and a few minor revenue components of its Colorado revenues and, notably, a conclusory statement that the costs of the Colorado sale (excluding sales, general and administrative expenses) equaled the sales price. There is no detailed breakdown of what costs are included and no detailed discussion of how and why each cost component is apportioned to Colorado rather than to other states.2 There is also no detailed discussion of the nature of revenues generated in other states which would allow us to determine whether and to what extent costs should be assigned to those revenues. The simplified chart of revenues and costs is aggregated information that lacks the detail needed to make an independent determination and contains numerous headers that are left unexplained. Company represents that separate accounting will show that it had a loss in Colorado. Company apparently does business in other states. Most states use some variation of the one, two, or three factor apportionment methodology rather than separate accounting. When Company prepares its income tax returns for other states, it will likely apportion a substantial portion of its taxable income to Colorado. However, Company will not report any taxable income on its Colorado income tax return if it allowed to use separate accounting. Under these circumstances, a substantial portion of Company’s income may not be taxed by any state. In general, the Department requires a company that is using an apportionment methodology different than those prescribed by Colorado statute or rule 2

2

Even a cursory review of the little information provided suggests areas of inquiry that are precluded by the lack of detailed information. For example, one would reasonably expect the ratio of costs of sale to revenues in 2013 (the year of the Colorado sale) to be larger than in other years if, as seems implicit in Company’s representations, costs for the 2013 sale in Colorado were larger than what Company typically incurs in a sale. However, the ratio of costs of sales to gross sales was actually smaller in 2013 than in the prior year (XXr% in 2012 and XX% in 2013). There may be an explanation for this, but we are not given the information needed to independently evaluate Company’s separate accounting. DR 4010A (06/11/14)

to use the same alternative apportionment methodology in every other state for which it files an income tax return. See, e.g., Department Rule 39-22-303.5.4(a)(6)(c). If Company will file in all states using the same separate accounting methodology if it is granted in Colorado, please affirm that you will do so. Company has a substantial burden to fully set forth the factual basis on which the Department can independently assess the merits of the petition. We find that Company has not met its burden of proof and persuasion that an alternative apportionment methodology is appropriate and, therefore, the request is denied. Pursuant to Colorado law, the enclosed redacted response to the petition for alternative apportionment will be published on the Department’s website.3 The purpose of the redaction is to remove confidential information relating to Company. Company has sixty days from the date of this response to submit in writing changes or objections to the proposed redaction.

Sincerely,

Office of Tax Policy
Colorado Department of Revenue

3

3

§§39-22-303.5(7)(d) and 24-35-103.5, C.R.S.
DR 4010A (06/11/14)