In Duke Energy Corporation,¹ the Supreme Court of South Carolina (Supreme Court) ruled that a taxpayer could not include the principal recovered from the sale of short-term securities from 1978 to 1999 in its sales factor for income tax apportionment purposes. In doing so, the Supreme Court affirmed the decision by the Court of Appeals, with a modified analysis.²

The taxpayer, Duke Energy Corporation (Duke), filed a refund claim for tax years 1978-2001 in the amount of $126,240,645. On its amended returns, Duke sought to include the principal recovered from sales of short-term investments in its sales factor denominator. In its original returns, Duke included only the interest or gain from those transactions. Both the Administrative Law Court and the Court of Appeals concluded that the principal is not includible in the sales factor. The Supreme Court granted Duke's petition for a writ of certiorari to review the Court of Appeals' decision.

For a majority of the years at issue, the statute defining the sales factor provided:

(A) The sales factor is a fraction in which the numerator is the total sales of the taxpayer in this State during the taxable year and the denominator is the total sales of the taxpayer everywhere during the taxable year.

(C) The word "sales" includes, but is not limited to:

...

(2)  sales of intangible personal property and receipts from services …

(S.C. Code Ann. Section 12-6-2280).

The Supreme Court indicated that the appropriate determination is whether principal recovered from the sale of short-term securities could be included as "total sales" in the sales factor. The legislative intent of the apportionment statutes is to reasonably represent the proportion of the taxpayer's business activity in South Carolina. The Supreme Court found that the inclusion of the principal portion of the sale of those securities produces absurd results that could not have been intended by the General Assembly. For example, the frequency of investments made would dictate how large or small Duke's "total sales" would be reflected in the denominator that really had no bearing on the business activities of Duke in the state. Thus, the inclusion of the principal from the sale of short-term securities would distort the sales factor and radically misrepresent the taxpayer's business activity in the State. The Supreme Court also referenced similar decisions from court cases in other states in its analysis.

Implications

The Supreme Court's analysis was focused more on the legislative intent and spirit of the apportionment statutes rather than a literal interpretation / analysis of the definition of "total sales" as set forth in the statute. As such, taxpayers should review their South Carolina apportionment methodology to ensure business activity within the State is reasonably represented. In this ruling, the Supreme Court also does not address the treatment of sales of all securities for purposes of determining the sales factor but rather only addresses those from the sale of "short-term" securities. The General Assembly, however, enacted S.C. Code Ann. Section 12-6-2295 defining sales effective for tax years after 2007. Section 12-6-2295(B) specifically excludes from the sales factor: the repayment, maturity, or redemption of the principal of certain securities and the principal received under a repurchase agreement or other transaction characterized as a loan. Accordingly, taxpayers should consider the definition of "sales" and "gross receipts" as provided in Section 12-6-2295 when determining their sales factor.

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ENDNOTES

¹ Duke Energy Corporation v. South Carolina Department of Revenue, Opinion No. 27606 (S.C. S. Ct. Feb. 17, 2016).

² See Tax Alert 2014-1939.