South Carolina: Court approves of taxpayer’s use of the standard statutory apportionment formula
In the case Rent-A-Center West, Inc. v. S.C. Dept of Revenue, the South Carolina Court of Appeals concluded that the Administrative Law Court (ALC) erred when it found that the standard statutory apportionment formula used by the plaintiff, Rent-A-Center West Inc. (RAC West), did not fairly represent RAC West's business activities in South Carolina. In concluding that ultimately, the South Carolina Department of Revenue (DOR) had failed to meet its burden of proof, the court reversed the ALC’s holding, which would have required RAC West to pay an additional $216,300 for the period at issue, 2003-2005.
RAC West is a subsidiary of Rent-A-Center, Inc., a rent to own business providing consumer goods to customers for rent. RAC West owns and operates stores in western states, and while it does not operate any retail stores in South Carolina, it owns and licenses the Rent-A-Center intellectual property, including the trademarks and trade names, to all other Rent-A-Center companies. Thus, RAC West’s only activity in South Carolina is the royalty payments it receives for the use of the intellectual property by all other Rent-A-Center companies.
For the tax years 2003, 2004, and 2005, RAC West filed its corporate tax returns using the three-factor apportionment formula consisting of property, payroll, and sales. In its audit, the DOR found that for these tax years, RAC West owed $144,971 in corporate income tax; $35,086 in interest; and $36,243 in penalties, for a total of $216,300. The DOR reasoned that RAC West’s only income in the state was from royalty payments, which required use of an alternative apportionment method because it “more fairly represented the taxpayer’s activity in South Carolina.” The DOR’s alternative method removed retail sales from the denominator of the sales factor of the apportionment formula, leaving only royalty payments in the denominator and increasing the sales factor.
RAC West appealed. Before the hearing, it amended its returns, changing its own computation method from the three-factor apportionment formula to the single-factor gross-receipts method. Under the gross receipts method, a taxpayer apportions its net income by using a ratio in which the numerator is the taxpayer’s gross receipts from within South Carolina during the taxable year, and the denominator is its total gross receipts from all states during the taxable year. The use of the gross receipts method triggered $1,326 more in tax liability for RAC West to what it had previously paid.
RAC West lost its appeal of the ALC decision, filed a motion for reconsideration, which it also lost, and took its case to the Court of Appeals.
The Court’s rationale
Citing statutory language and case law, the appellate court acknowledged that for the activities at issue in this case, the threshold issue was whether the statutory formula fairly represented RAC West’s business activity within South Carolina. RAC West argued that it did, and the burden of proof was on the DOR to show otherwise.
As an initial matter, the DOR’s auditor was unable to point to any specific evidence that the standard apportionment method did not fairly represent RAC West's business activities.
Next, though an expert witness for the DOR testified that using the standard apportionment method would be like having apples in the numerator while having apples and oranges in the denominator, a RAC West expert witness testified that this is how the apportionment method is intended to work.
The court also looked to a previous South Carolina Supreme Court case in which Eastman Kodak was the plaintiff. That case established that “[t]he fact that a very small percentage of the leased assets are located in South Carolina is accounted for in the numerator of the apportionment formula in which Kodak's payroll, property, and sales in this state are computed. Therefore, the apportionment formula reflects a 'reasonable representation' of Kodak's business in this state.” Applying that case law, the court asserted that “[a] very small amount of RAC West's business comes from the royalties; therefore, this should only comprise a small amount of its taxes.
For these reasons, the court concluded that the evidence did not show that the DOR met its burden, in contrast to the ALC ‘s finding that it did. Accordingly, the appellate court reversed.