On October 31, 2018, the South Carolina Court of Appeals (the Court) found that Dish DBS Corporation (Dish or Taxpayer) failed to prove that the corporate income tax assessment issued by the South Carolina Department of Revenue (SCDOR) on the proper apportionment of income from the provision of satellite signals to South Carolina subscribers was erroneous.¹ Dish had appealed the decision of the Administrative Law Court's (ALC) affirming the SCDOR's assessment, raising multiple issues:

1. Was the testimony of SCDOR's expert reliable since he was an expert in applied economics?

The SCDOR's witness was an author, teacher and researcher in the area of applied economics but he was not an expert in state income tax apportionment or income producing activities (IPAs). The Court held that the ALC properly admitted his testimony "from an economic standpoint" and, not necessarily, from a statutory interpretation standpoint, because his field of expertise "deals with income, revenue, and costs [and] concepts of intermediate inputs and final products."

2. Did the ALC correctly determine that South Carolina is not a pro rata cost of performance state?

The Court found that the ALC correctly relied on S.C. Code Ann. Section 12-6-2290 and Section 12-6-2295 to conclude that a service provider's receipts are attributed to the state to the extent its IPAs are performed in that state. The language in these statutes is similar to that found in the Uniform Division of Income for Tax Purposes (UDITPA), but the South Carolina legislature specifically excluded the cost of performance (COP) language mentioned in UDITPA.

3. Did the administrative court not adopt a market-share approach for apportioning multi-state income?

The Court found that the ALC repeatedly stated that South Carolina is not a market-share state. Instead, the ALC said that South Carolina " … provides a flexible standard based upon [IPA] for a given industry." As opposed to Dish's view, the Court seemed to find that this would not result in a market-share approach for every taxpayer.

4. Were Taxpayer's IPAs — the delivery of its satellite signal to its subscribers — best represented by its South Carolina subscription receipts?

Citing DIRECTV, Inc., 421 S.C. at 77, 804 S.E.2d at 642 (DIRECTV), the Court said that Dish's IPA similarly was " … the delivery of its programming signal to its customers." This agreed with SCDOR's expert witness, who claimed Dish's other activities to be merely "intermediate inputs." Given that the IPA determination in Dish is similar to the IPA determination in DIRECTV, the Court found no "substantial evidence in the record or … an error of law" necessary to reverse the ALC's order (Original Blue Ribbon Taxi Corp., 380 S.C. at 604, 670 S.E.2d at 676).

5. Did the SCDOR properly impose substantial understatement penalties?

While Dish claimed that it had reasonable cause and acted in good faith in filing its tax returns based on its position, the Court determined that substantial evidence supported the ALC's decision to find that Dish had no substantial authority or reasonable cause for its position on its tax returns. Specifically:

• S.C. Code Ann. Section 12-6-2295 does not mention COP
• Dish's reliance on another taxpayer's case was unfounded due to the differences between the two businesses
• The South Carolina Income Tax Manual, to which Dish referred, states that South Carolina is not a COP state
• A co-author of the Hellerstein Treatise, to which Dish also referred, stated that the treatise does not classify South Carolina as a COP state

Accordingly, the Court affirmed the ALC's decision on all of these issues.

Implications

This ruling provides further support for the view that South Carolina is neither a "COP" nor "market-sourcing" state for sourcing receipts from services for sales factor apportionment purposes. Rather, South Carolina seeks to determine what a taxpayer's income-producing activity is and where that activity occurs. Since South Carolina law does not define "IPA," that determination requires a stringent factual analysis. A key factor in this analysis is to determine a direct link between the potential IPA and the final product or service that creates the revenue.

Taxpayers looking to apportion revenue from the sale of services related to specific activities must be very detailed and diligent in how they present their IPA for South Carolina purposes. Specifically, companies must clearly differentiate IPA from preparatory activities.

At this time, it is uncertain whether Dish will appeal this ruling.

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ENDNOTES

¹ Dish DBS Corp. v. Dep't of Revenue, No. 2018-UP-404 (S.C. Ct. App. Oct. 31, 2018).