NOTICE: IC § 4-22-7-7 permits the publication of this document in the Indiana Register. The publication of this document provides the general public with information about the Indiana Department of Revenue's official position concerning a specific set of facts and issues. The "Holding" section of this document is provided for the convenience of the reader and is not part of the analysis contained in this Memorandum of Decision.

Out-of-State Corporation demonstrated that it was entitled to a reduction of its Indiana sales factor because sales in foreign jurisdictions should not have been sourced to Indiana under the throwback rule.

I. Adjusted Gross Income Tax - Throwback Sales.

Authority: 15 U.S.C. § 381; IC § 6-3-2-2; Sherwin-Williams Co. v. Indiana Dep't. of State Revenue, 673 N.E.2d 849 (Ind. Tax Ct. 1996); 45 IAC 3.1-1-38; 45 IAC 3.1-1-53; 45 IAC 3.1-1-64; Tax Policy Directive 6 (June 1992); Letter of Findings 02-20140358 (January 2015).

Taxpayer maintains that sales to customers located in various foreign jurisdictions should not be thrown back to Indiana because Taxpayer has nexus in those jurisdictions.

Taxpayer is an out-of-state corporation doing business in Indiana and worldwide. As part of its operations, Taxpayer licenses intellectual property to foreign affiliates in various countries around the world. Taxpayer has two locations in Indiana; thus it elects to file a separate Indiana income tax return based on its nexus with Indiana.

The Indiana Department of Revenue ("Department") conducted an audit on Taxpayer's business for the 2009 through 2011 tax years. The audit report contained various adjustments to Taxpayer's 2011 return, including increasing its income apportionable to Indiana and an adjustment decreasing its Indiana apportionment factor. The Department previously determined that income received by Taxpayer's subsidiaries for licensing intellectual property must be included in Taxpayer's adjusted gross income in order to fairly reflect Taxpayer's reported total adjusted income to cure distortion in the reporting of Taxpayer's income. See Letter of Findings 02-20140358 (January 2015), 20150128 Ind. Reg. 045150015NRA.

Subsequent to the audit, Taxpayer amended its 2011 Indiana corporate income tax return by filing an IT-20X form, using the adjustments made during the audit as a starting point. Taxpayer's amended return purports to exclude income from foreign jurisdictions in which Taxpayer claims it had nexus, and therefore should not have been included in the Indiana sales factor numerator. The amended return requested a refund and an increased Indiana Research Expense Tax Credit carryover.

The Department did not accept Taxpayer's amended return as filed, thus denying Taxpayer's claim for refund. The refund denial letter stated, "The refund has been denied due to the amended changes did not reflect the previous Indiana Audit changes under Audit Control # [XXXXXX]." The Department did not make a substantive determination on the sales apportionment issue.

Taxpayer subsequently filed the instant protest. An administrative hearing was held during which Taxpayer's representative explained the basis of its protest, and this Memorandum of Decision results. Further facts will be provided as necessary.

I. Adjusted Gross Income Tax - Throwback Sales.

The issue is whether Taxpayer was entitled to a refund of tax on its apportionable income previously adjusted by the Department's audit because the throwback rule does not apply to its sales of tangible personal property in various foreign jurisdictions. Specifically, Taxpayer stated that it had mistakenly included income from receipts in foreign jurisdictions in its Indiana sales based on the "throwback rule," and therefore requested a refund based on the revised apportionment formula. During the protest, Taxpayer provided documentation for several foreign jurisdictions to support its assertion that it had nexus with the country, and that it would be subject to jurisdiction for the imposition of a net income tax. The Department rejected the amendments to Taxpayer's 2011 return without addressing Taxpayer's argument regarding throwback sales.

"Indiana imposes a tax on every corporation's adjusted gross income derived from sources within Indiana. [IC § 6-3-2-1(b).] In cases where a corporation derives business income from sources both within and without Indiana, the 'adjusted gross income derived from sources within the state of Indiana' is determined by an apportionment formula." Sherwin-Williams Co. v. Indiana Dep't. of State Revenue, 673 N.E.2d 849, 851 (Ind. Tax Ct. 1996). For all tax years after December 31, 2010, the formula operates by multiplying taxpayer's total business income by a fraction composed of a sales factor. IC § 6-3-2-2(b)(5). The "sales factor" consists of a fraction, "the numerator of which is the total sales of the taxpayer in [Indiana] during the taxable year, and the denominator of which is the total sales of the taxpayer everywhere during the taxable year." IC § 6-3-2-2(e).

IC § 6-3-2-2(a) (2011), in pertinent part, states that Indiana taxpayers are subject to this state's income tax on money earned from doing business within this state:

However, IC § 6-3-2-2(n) (2011) provides that a taxpayer's income is not subject to this state's income tax if that income is attributable to conducting business in another state in which it is subject to that foreign state's own tax regime:

The issue then becomes whether Taxpayer's activities brought itself within the purview of the foreign countries' income tax regimes. 15 U.S.C. § 381(a) (Public Law 86-272) establishes the minimum standards under which Indiana or any foreign state may permissibly impose tax. In relevant part, the law provides as follows:

15 U.S.C. § 381(c) explains under what conditions a company is not conducting business in another state:

In summary, Public Law 86-272 prohibits states from imposing a net income tax on a foreign taxpayer if the foreign taxpayer's only business activity within that state is the solicitation of sales. A state may not impose an income tax on income derived from business activities within that state unless those activities exceed the "mere solicitation" of sales.

In this instance, Taxpayer has foreign subsidiaries or affiliates in various foreign jurisdictions outside of the United States. In the prior audit, the Department determined that royalty income from Taxpayer's foreign subsidiary that licenses Taxpayer's intellectual property ("IP Subsidiary") must be allocated to Taxpayer under IC § 6-3-2-2(l) and (m) in order to fairly reflect Taxpayer's total adjusted gross income. Royalty income from the IP Subsidiary was also included in the denominator of Taxpayer's apportionment factor. Taxpayer now asserts that the activities of its subsidiaries in 42 foreign jurisdictions exceed the protections of P.L.86-272, thus giving Taxpayer nexus with those countries. Taxpayer asserts that either royalty income received by Taxpayer's subsidiaries from the use of intellectual property in foreign jurisdictions, or the presence of employees providing more than mere solicitation, provides sufficient nexus with these countries such that the throwback rule is inapplicable to sales in these countries.

As a general rule, the nexus of a subsidiary or affiliate is not attributed to the parent company unless the entities file a unitary/combined return. This is known as the Finnigan concept. Tax Policy Directive 6 (June 1992) states, "Under Finnigan, sales made by a member of the unitary group to a destination in another state in which that member was not taxable should not be "thrown back" to Indiana unless no member of the unitary group was taxable in the other state . . . . The adoption of Finnigan only applies to corporations who file unitary/combined returns in Indiana . . . . Corporations not filing combined/unitary returns in Indiana will continue to apply the throwback sales rule in the normal fashion." (Emphasis in original).

Although under these circumstances Taxpayer did not file a combined return with IP Subsidiary under IC § 6-3-2-2(p), the Department's prior audit required Taxpayer to include the royalty income from IP Subsidiary in its total income in order to correct distortion under IC § 6-3-2-2(l) and (m). By allocating the royalty income to Taxpayer, the Department's prior audit implicitly considered that Taxpayer's subsidiaries' nexus could be attributable to Taxpayer concerning the income at issue. Therefore, for purposes of Taxpayer's apportionment computation for 2011, the Department will apply the Finnigan concept and consider the IP Subsidiary's nexus in determining where Taxpayer's income from foreign jurisdictions should be sourced. Application of the Finnigan concept under these circumstances is as a matter of equity under these particular set of facts.

In its amended 2011 income tax return, Taxpayer sought to exclude income from 42 countries. To support its protest, Taxpayer provided documentation for eight countries showing that the countries had laws enacted that would subject Taxpayer to a "net income tax, a franchise tax measured by net income, a franchise tax for the privilege of doing business, or a corporate stock tax" as stated in IC § 6-3-2-2(n), and that Taxpayer or Taxpayer's IP subsidiary either had employees working in those countries or that intellectual property was licensed for use in that country such that those countries would have jurisdiction to impose a net income tax. These countries include Germany, Canada, Great Britain, China, Indonesia, South Korea, Thailand, and Singapore. For each of these countries, Taxpayer provided copies of Trademark and Technology License and Technical Services Agreements evidencing that the IP Subsidiary both licensed intangible property and provided personnel for technical assistance with manufacturing and application of the intangible property. Taxpayer did not provide adequate documentation for the remaining 34 countries.

Upon reviewing Taxpayer's documentation, the Department agrees that Taxpayer's documentation demonstrated that its subsidiaries' activities in Germany, Canada, Great Britain, China, Indonesia, South Korea, Thailand, and Singapore exceeded the P.L.86-272's protection, and that it would be subject to a net income tax in those countries. Thus, the Indiana throwback rule should not apply to the income derived from Taxpayer's sales to Germany, Canada, Great Britain, China, Indonesia, South Korea, Thailand, and Singapore for tax year 2011. Taxpayer's protest with respect to income from Germany, Canada, Great Britain, China, Indonesia, South Korea, Thailand, and Singapore is sustained. Taxpayer's protest with respect to the income from the remaining countries is denied.

Taxpayer's protest is sustained in part with respect to income from Germany, Canada, Great Britain, China, Indonesia, South Korea, Thailand, and Singapore, and denied in part with respect to income from the remaining countries under protest.