In DIRECTV, Inc. v. South Carolina Department of Revenue,¹ the South Carolina Court of Appeals (COA) affirmed the decision of the Administrative Law Court (ALC) upholding the South Carolina Department of Revenue's (the Department) denial of a multistate company's claims for refunds of South Carolina corporate income and license fee taxes, interest and penalties. The COA agreed with the ALC that the company's income producing activities relating to South Carolina customers occurred entirely within South Carolina, and sustained the ALC's assessment of understatement penalties based on the conclusion that the company did not show reasonable cause for the tax underpayment.

DIRECTV, Inc. (DIRECTV) is a multistate company that offers direct broadcast satellite video services to customers throughout the United States, including South Carolina. Customers pay DIRECTV a subscription fee for access to television programming channels and other audio/visual options that are transmitted nationwide to customers' homes or businesses via satellites. As a service provider subject to South Carolina corporate income tax, DIRECTV is required to apportion its income to South Carolina using a fraction in which the numerator is gross receipts from within South Carolina and the denominator is total gross receipts from everywhere.² For tax years 2006 through 2008, DIRECTV filed corporate income tax returns in South Carolina in which it included 100% of subscription receipts from South Carolina customers in the numerator of the gross receipts ratio. DIRECTV requested refunds by filing amended returns to exclude all subscription receipts from the numerator of its gross receipts ratio. DIRECTV also excluded all subscription receipts from the numerator on its original 2009 through 2011 returns. The Department denied the amended returns and related refunds and instead assessed DIRECTV for income taxes, license fees, interest, and substantial understatement penalties for 2009 through 2011 using a gross receipts ratio that included all of the subscription receipts from South Carolina customers in the numerator.

Under South Carolina statutory law,³ receipts from services are in South Carolina if the entire income-producing activity is within 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 occurs within South Carolina. The relevant issue in the case involved determining what the income-producing activity is, and where that activity occurs. The Department argued, and the ALC agreed, that the only income-producing activity is the delivery of the signal into the homes and onto the television screens of DIRECTV's customers and, therefore, 100% of the subscription receipts from South Carolina customers should be sourced to South Carolina.

DIRECTV appealed the ALC ruling, and relying on the precedent set forth in Lockwood Greene Engineers, Inc. v. S.C. Tax Commissioner,⁴ argued for a "place of activity" view, which apportions income based on the place where the services are performed. DIRECTV argued that its income-producing activities in South Carolina are based on four value drivers: 1) content and programming, 2) acquisition and distribution of the content to customers, 3) marketing and sale of its service, and 4) customer services.

The COA did not find DIRCTV's reliance on Lockwood persuasive because of the differences between the two cases. In Lockwood there was a direct link between the engineering services revenue earned by Lockwood Greene Engineers, Inc. (Lockwood) and the time worked by their engineers. In the current case, however, there is not direct correlation between all of the income-producing activities suggested by DIRECTV and their subscription revenue. The COA concluded that any preparatory activities that DIRECTV engages in to gain more subscriptions are not income-producing activities, but "income-anticipatory" activities. The COA agreed with the ALC and Department's determination that DIRECTV 's only income-producing activity is the delivery of the signal into the homes and onto the television sets of its customers, and that 100% of its subscription receipts from South Carolina customers must be sourced to South Carolina since all of the income-producing activities related to South Carolina customers occurred entirely within South Carolina. Ultimately, the COA denied DIRECTV's refund requests and affirmed the ALC's order regarding assessed additional tax, license fees, interest and penalties.

Implications

This case provides further support for the view that South Carolina is neither a "cost of performance" nor "market-sourcing" state for sourcing receipts from services. Rather, South Carolina will seek to determine what the taxpayer's income-producing activity is and where that activity occurs. Since South Carolina law does not define "income producing activity," that determination requires a stringent factual analysis. A key factor in this analysis is to determine a direct link between the potential income-producing activities and the final product or service that creates the revenue. Companies that are looking to apportion their income based on specific activities must be very detailed and diligent in how they present their income-producing activities for South Carolina purposes. Specifically, companies must clearly differentiate income producing activities from preparatory activities. Additionally, taxpayers should consider the implications of this case on South Carolina corporate income tax filings (both prior and future years) and when evaluating potential reserves for uncertain tax positions.

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ENDNOTES

¹ DIRECTV, Inc. & Subsidiaries v. South Carolina Department of Revenue, No. 5513 (S.C. Ct. of App. Aug. 30, 2017) affirming, DIRECTV, Inc. & Subsidiaries v. South Carolina Department of Revenue, No. 14-ALJ-17-0158-CC (S.C. Admin. Law Ct. May 12, 2015).

² S.C. Code Ann. Section 12-6-2290.

³ S.C. Code Ann. Section 12-6-2295(A)(5).

⁴ Lockwood Greene Engineers, Inc. v. S.C. Tax Commissioner, 293 S.C. 447, 449, 361 S.E.2d 346, 347 (Ct. App. 1987).