Apportionment Issues: Redemptions of Short-Term Marketable Securities: The Microsoft Case

Schadewald, Michael
November 2006
Journal of State Taxation;Nov/Dec2006, Vol. 25 Issue 1, p9
Academic Journal
In recent years, numerous states have wrestled with the issue of how to apply UDITPA apportionment rules to income and gross receipts arising from the cash management activities of corporate treasury departments; in particular, the income and gross receipts arising from short-term investments in marketable securities. In a much anticipated ruling on this issue, the California Supreme Court ruled that the entire amount of gross receipts, including both income and return of capital, from marketable securities redeemed at maturity is includible in the sales factor. The court also ruled, however, that the Franchise Tax Board had established that the standard apportionment provisions did not fairly represent Microsoft's business activities in California, and that an alternate formula should be used to calculate the apportionment percentage under the state's equitable relief provision [Microsoft Corp. v. Franchise Tax Board, No. S133343 (39 Cal. 4th 750) Aug. 17, 2006]. The fundamental issue in this case was the proper method of computing Microsoft's California sales factor. Consistent with UDITPA ��1(g) and 18, respectively, California �25120(e) defines sales as �all gross receipts� of the taxpayer, and California �25137 provides that if the state's standard apportionment provisions �do not fairly represent the extent of the taxpayer's business activity in this state,� the taxpayer may seek or the Franchise Tax Board (FTB) may, if reasonable, require the use of an alternate apportionment method to achieve an equitable result. In its amended 1991 California tax return, Microsoft reported the income of its treasury department as business income, and also reported the entire $5.7 billion it received from sales and redemptions of investments in short-term marketable securities as gross receipts. In its audit, the FTB accepted the treatment as gross receipts of securities resold to third parties prior to maturity, but excluded from gross receipts the return-of-capital portion of securities redeemed at maturity. That is, for securities held to maturity, the FTB treated only the excess of the redemption price over the purchase price as gross receipts. Including only the net receipts rather than the full redemption price in the California sales factor increased Microsoft's California apportionment percentage because receipts from security transactions were attributed to the State of Washington, where Microsoft's treasury department operations were located. The trial court ruled that the full redemption price of marketable securities redeemed at maturity was includible in Microsoft's sales factor, and that the FTB had failed to demonstrate that the use of an alternate apportionment method was necessary to achieve a fair representation of Microsoft's business activity in California. The Court of Appeal reversed, deciding the case solely on the grounds of California �25137. It held that including the return-of-capital portion of the redemption amount in gross receipts seriously distorted the representation of Microsoft's business activity in California, and that the FTB's alternate apportionment method, which included only the net receipts in the sales factor, was reasonable. The California Supreme Court affirmed the appellate court's ruling.


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