This Alert serves as a follow-up to the Alert published on February 18, 2015¹ in which an administrative law judge (ALJ) denied cross motions for summary judgment regarding corporate income tax apportionment. In Dish DBS Corporation v. South Carolina Department of Revenue,² the ALJ ruled on the proper way to apply South Carolina's "income-producing activity" provisions as they apply to a satellite television provider. The ALJ concluded that South Carolina is not a cost-of-performance state or a market-based sourcing state. Instead, South Carolina statutes provide an apportionment standard based on where the "income-producing activity" takes place.

Dish DBS Corporation (Dish) is engaged in providing access to digital television entertainment across the United States, including South Carolina. As a multi-media broadcast corporation, Dish provides services through the transmission of digital signals from several satellites to receiver boxes located in subscribers' homes. Dish also maintains an infrastructure to support its services. The infrastructure includes uplink centers, broadcast centers, customer call centers, service and remanufacturing centers, and warehouses. One of Dish's service and remanufacturing facilities is located in South Carolina. A portion of Dish's revenue from customers includes monthly fees for subscribing to one or more programming packages (including pay-per view programming). For purposes of calculating its South Carolina income tax liability, Dish generally used the cost of performance sourcing method to source its receipts. Using such method, Dish only sourced a portion of its South Carolina subscription receipts to South Carolina. During an audit, the South Carolina Department of Revenue (the Department) asserted that Dish should be using the "gross receipts" apportionment method and sourcing all of its receipts from South Carolina subscribers to South Carolina. The issue in the case was whether the Department correctly assessed and calculated Dish's income tax liability following its audit of tax years 2004-2010.

South Carolina's apportionment statute states that receipts from the sale of services are sourced to South Carolina if the income-producing activity is performed in South Carolina. If the income-producing activity is performed partly within and partly outside South Carolina, sales are attributable to South Carolina to the extent the income-producing activity is performed within South Carolina (S.C. Code Ann. Section 12-6- 2295(A)(5)).The ALJ noted two distinct differences between the method described by South Carolina statute and the cost-of-performance method provided in Section 17 of the Uniform Division of Income for Tax Purposes Act (UDITPA).³ First, South Carolina chose not to include the phrase "cost of performance" in its statute. Second, the statute does not include language indicating that the sourcing of receipts to South Carolina is determined on an "all-or-nothing" basis as it appears to be in UDITPA, in which revenues from sales of other than tangible personal property are sourced solely to the state in which the greatest proportion of the income-producing activity is performed. As such, the ALJ concluded that South Carolina is not a strict "cost-of-performance" state. Additionally, the South Carolina statute does not reference a proxy (e.g., costs of performance) to measure the income-producing activity. Therefore, the ALJ further concluded that South Carolina is not a pro rata cost-of-performance state. The ALJ also found that South Carolina is not a "market share" or "audience" state (i.e., a sourcing method that would source sales based on where a taxpayer's customers are located). Instead, the South Carolina statute focuses solely on the extent the "income-producing activity" is performed in South Carolina. The term, "income-producing activity," is not defined by the statute. Relying on prior case law and statutory interpretation, the ALJ noted that a flexible standard applies based on where the income-producing activity takes place for a given industry.

Dish argued that it has eight different income-producing activities, including: (1) the acquisition of programming/content, (2) the operation of satellites and uplink centers, (3) advertising, (4) providing subscriber equipment, (5) installation of equipment, (6) in-home repair, (7) the operation of call centers, and (8) general and administrative activities. In contrast, the Department argued that Dish's income-producing activity is limited to the delivery of a signal into the customer's home and onto the customer's television set. The Department argued that the various activities of Dish are intermediate inputs that generate costs rather than income. The ALJ ultimately agreed with the Department's position that the income-producing activity is the delivery of a signal into the customer's home and onto the customer's television. The ALJ noted that preparatory activities identified by Dish contribute to the delivery of Dish's signal to subscribers, but they are not activities that customers would pay for separately without access to Dish's programming on their television sets. Additionally, Dish did not provide sufficient evidence to show the effect advertising had on its South Carolina revenue (Dish merely presented evidence of its advertising costs within and outside South Carolina). The ALJ found that the South Carolina subscription receipts are directly tied to the income-producing activity and most accurately reflect Dish's proportion of business carried on within South Carolina. All of the income-producing activity — the delivery of Dish's signal into South Carolina subscribers' homes and onto their television sets - occurs within South Carolina. Therefore, the Department properly sourced 100% of Dish's South Carolina subscription receipts to South Carolina. The ALJ also concluded that Dish had no substantial authority to use a cost-of-performance sourcing method and the Department properly calculated and assessed tax, penalties, and interest.

Implications

This case highlights the ambiguity of South Carolina's apportionment and allocation statutes. South Carolina's statute does not include language typical of those states that apply a cost of performance methodology or a market-based sourcing methodology. Accordingly, taxpayers and the Department alike have been challenged in applying sales factor sourcing methodologies for various industries, and have commonly been debating this issue under exam. While the ruling in the Dish case does not provide broad certainty on the sourcing of services, it does provide precedent stipulating that South Carolina is neither a "cost-of-performance" nor a "market-sourcing" state for sales factor sourcing purposes, and further that the determination of the "income-producing activity" test demands a stringent factual analysis.

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ENDNOTES

¹ See Tax Alert 2015-2386.

² Dish DBS Corp, f/k/a/ EchoStar DBS Corp., and Affiliates v. South Carolina Department of Revenue, South Carolina, Administrative Law Judge Division, No. 14-ALJ-17-0285-CC (S.C. Admin. Law Ct. May 20, 2016).

³ Section 17 of UDITPA utilizes standard cost of performance language: "Sales, other than sales of tangible personal property, are in this State if: (a) the income-producing activity is performed in this State; or (b) the income-producing activity is performed both in and outside this State and a greater proportion of the income-producing activity is performed in this State than in any other State, based on costs of performance."