Is this B ad S ourcing and Allocation or just Inconsistency ?

1. Is this Bad Sourcing and Allocation or just Inconsistency? Taxpayers’ Federation of Illinois 11th Annual Illinois State and Local Tax Conference September 23, 2010 Scott Heyman David Kupiec Ronald Cook Sidley Austin LLP Kupiec & Martin, LLC Exelon Corp. (312) 853-7501 (312) 632-1022 (312) 394-3088

2. Illinois Sales Factor • Where is Illinois currently? • New Law • New and Proposed Regulations • Where has Illinois been? • Where is Illinois going?

3. Illinois Sales Factor • 304(a)(3)(A): The sales factor is a fraction, the numerator of which is the total sales of the person in this State during the taxable year, and the denominator of which is the total sales of the person everywhere during the taxable year.

4. Sales of TPP – In General • Sales of tangible personal property are in this State if the property is delivered or shipped to a purchaser, other than the United States government, within this State regardless of the f.o.b. point or other conditions of the sale. §304(a)(3)(B)(i)

5. Sales other than TPP—In General • Cost of Performance • A function of the direct costs associated with the income-producing activity. • UDITPA methodology sources the sales to the single state in which the greatest costs of performance are incurred. • The application of this methodology can result in somewhat arbitrary sourcing. For example, if the costs of performance are incurred 30% in state A; 20% in each of states B , C, and D; and 10% in state E, then all of the sales would be sourced to state A, the state in which the greatest costs of performance were incurred. • MTC model regulation that calculates sales factor using “costs of performance” for sourcing transactions other than sales of tangible personal property. Amendments being discussed applies market based based sourcing. • Modified Costs of Performance • A function of direct costs associated with the income-producing activity. • Sources sales to multiple states based on the proportionate amount of the costs of performance incurred in each state. • Marketplace • Some states source sale entirely to state in which service is received by the customer. • Other states source a portion of the sale to the state based on the proportion of the service received in the state by the customer. • Effect of varying rules in the states means that a taxpayer could have a 100% sales factor in a cost of performance state and a 100% sales factor in a marketplace sourcing state.

6. Sales of Services—Historical Illinois Treatment • Sales of services are in this State if: • The income-producing activity is performed in this State; or • The income-producing activity is performed both within and without this State and a greater proportion of the income-producing activity is performed within this State than without this State, based on performance costs. §304(a)(3)(C)(ii).

7. Sales of Services—Current Illinois Treatment General rule: Sales of services are in this State if the services are received in this State. 304(a)(3)(C-5)(iv)

8. Sales of Services—Ordering • Gross receipts from the performance of services are sourced to Illinois if they are received in Illinois. Gross receipts from the performance of services provided to a corporation, partnership, or trust: • May be attributed only to a state where that corporation, partnership, or trust has a fixed place of business. • If the state where the services are received is not readily determinable or is a state where the corporation, partnership, or trust receiving the service does not have a fixed place of business, the services shall be deemed to be received at the location of the office of the customer from which the services were ordered in the regular course of the customer's trade or business. • If the ordering office cannot be determined, the services shall be deemed to be received at the office of the customer to which the services are billed. • If the taxpayer is not taxable in the state in which the services are received, the sale must be “thrown out” from both the numerator and the denominator of the sales factor. 304(a)(3)(C-5)(iv)

9. Sales of Intangible Personal Property • Dealers source receipts from intangible property to Illinois if the customer is in Illinois (individuals, trusts and estates are in Illinois if Illinois residents; others are in Illinois if they have an Illinois commercial domicile) . 304(a)(3)(C-5)(iii)(a). • Persons other than dealers continue to use cost of performance. 304(a)(3)(C-5)(iii)(b).

10. Financial Organizations • Receipts from services (304(c)(3)(vi)): considered in the State if the services are received in this State within the meaning of 304(a)(3)(C-5)(iv) (general sales of services provision discussed above) • Receipts from interest income (304(c)(3)(ii)-(v)): • From loans secured by real estate or TPP – in this State if the real estate or TPP is located in this State • From consumer loans – in this State if the debtor is a resident of this State • From commercial loans not secured by real estate or TPP – in this State if the loan proceeds are to be applied in this State • From credit card receivables – in this State if the card charges are regularly billed to a customer in this State • Receipts from investment income (304(c)(3)(viii)): – complex rules

11. Where has Illinois been and what is currently going on with old issues? • Not a lot of guidance regarding new statutes and regulations • Still auditing cost of performance issues • Cost of performance still applicable for some sales – statutory change? • Will Illinois look to MTC or other states’ litigation and positions?

12. Illinois Sourcing Regulations – In Process • General Services Sourcing • Publishing Sourcing • Transportation Sourcing • Business Hedging • Electricity Sourcing

13. Where is Illinois going?New Areas of Focus • Audits/Auditor Interpretation and Discretion • Statutory Changes • Regulatory Changes • Case law • Alternative Apportionment

14. MTC – Revisions to Article IV • Market Sourcing • Throwout • Drafted specified location for four transaction types • Lease of TPP – location of property • Sale or lease of real property – location of property • Sale or lease of intangibles – to the location of use • Sale of services – location of delivery; and if that location cannot be determined, it shall be reasonably approximated

15. Texas and Michigan - MTC • Texas has explained in a Tax Policy newsletter that the apportionment provision in Texas Code Chapter 141, related to the Multistate Tax Compact, does not apply to the revised Texas franchise tax and entities may not elect to use the MTC’s three-factor apportionment formula in lieu of the formula specified in Texas Tax Code Chapter 141. • Proposed Michigan legislation would bar taxpayers from using the three-factor MTC apportionment formula as well (H.B. 6351).

16. Wisconsin – Cost of Performance • Ameritech Publishing, Inc . v. Wisconsin Department of Revenue (Appeal No. 2009AP445, June 24, 2010) Service of providing access to Wisconsin consumer is income-producing activity – regardless of the state in which sales persons and advertising production staff were located, primary service of providing access to a Wisconsin audience was performed in the state of WI.

17. Oklahoma – Market Sourcing • Oklahoma recently enacted market sourcing in Regulation 710:50-17-71 • It provides that receipts from services are included if the “receipts are otherwise attributable to the state’s marketplace” • A customer within Oklahoma means: • A customer that is engaged in a trade or business and maintains a regular place of business in Oklahoma, or • A customer that is not engaged in a trade or business whose billing address is Oklahoma. A “billing address” means the location indicated in the books and records of the taxpayer as the address of record where the bill relating to the customer’s account is mailed.

18. Washington – Market Sourcing • Washington (2ESSB 6143) – market-based sourcing, gross income from each apportionable activity is attributed: • To state where the service was primarily received or the intangible property primarily used in cases where there is benefit in more than one state. • To state where the customer ordered the service or where the royalty agreement was negotiated. • To state where Customer billing statements or invoices are sent. • To state from which the customer sends payment to taxpayer. • To state where customer is located as indicated by customer’s address as shown in the taxpayer’s business records. • To state where the business is domiciled.

19. New Jersey - Throwout • Whirlpool Properties and Pfizer (Docket No. A-1180-08T2 A-1182-08T2) – New Jersey Appellate Division held that the “throwout” rule is facially constitutional in that it does not offend the Due Process, Commerce or Supremacy Clause of the U.S. Constitution • The court found that the “throwout” rule does not expose any income to multiple taxation and does not tax in-state and out-of-state sales in a discriminatory manner

20. Maine - Throwout • Maine – throwout: sales factor must exclude from both the numerator and denominator sales of tangible personal property delivered or shipped by the taxpayer to a purchaser within a state in which the taxpayer is not taxable, unless any member of an affiliated group with which the taxpayer conducts a unitary business is taxable in that state. (Enacted March 31, 2010; Effective for tax years beginning on or after January 1, 2010)

21. California • For taxable years beginning on or after January 1, 2011, sales, other than sales of tangible personal property, are in California as follows: (1) Sales from services to the extent the purchaser of the service received the benefit of the service in California. (2) Sales from intangible property to the extent the property is used in California. (3) Sales from the sale, lease, rental, or licensing of real property if the real property is located in California. (4) Sales from the rental, lease, or licensing of tangible personal property if the property is located in California. Cal. Rev. & Tax. Cd. § 25136

22. California • Effective since February 2009, sales of tangible personal property are in California if: (1) The property is delivered or shipped to a purchaser, other than the United States government, within California regardless of the f.o.b. point or other conditions of the sale. (2) The property is shipped from an office, store, warehouse, factory, or other place of storage in California and (A) the purchaser is the United States government or (B) the taxpayer is not taxable in the state of the purchaser. Cal. Rev. & Tax Cd. § 25135(a)

23. California In 2011, California will switch from the Joyce Rule to the Finnegan Rule: For taxable years beginning on or after January 1, 2011, for purposes of determining whether sales are in California and included in the numerator of the sales factor, all sales of the combined reporting group properly assigned to California shall be included in the sales factor numerator for California regardless of whether the member of the combined reporting group making the sale is subject to the corporate franchise or corporate income tax. All sales not assigned to California pursuant to subdivision (a) shall not be included in the sales factor numerator for California if a member of the combined reporting group of the taxpayer is taxable in the state of the purchaser. Cal. Rev. & Tax Cd. § 25135(b).

24. California Beginning in 2011, certain businesses will be able to elect to apportion income to California using a single sales factor apportionment formula for corporate income tax purposes. Cal. Rev. & Tax. Cd. §25128.5(a)

25. Other States’ Provisions • Minn. Rev. Stat. Sec. 290.191.Subd.5.(j) • “Receipts from the performance of services must be attributed to the state where the services are received. For the purposes of this section, receipts from the performance of services provided to a corporation, partnership, or trust may only be attributed to a state where it has a fixed place of doing business. If the state where the services are received is not readily determinable or is a state where the corporation, partnership, or trust receiving the service does not have a fixed place of doing business, the services shall be deemed to be received at the location of the office of the customer from which the services were ordered in the regular course of the customer's trade or business. If the ordering office cannot be determined, the services shall be deemed to be received at the office of the customer to which the services are billed.”

26. Other States’ Provisions • Ohio Rev. Code Sec. 5733.05B(2)(c)(ii) (franchise tax) and Ohio Rule 5703-29-17 (Commercial Activity Tax) • “Receipts from the sale of services, …shall be sitused to this state in the proportion to the purchaser's benefit, with respect to the sale, in this state to the purchaser's benefit, with respect to the sale, everywhere. The physical location where the purchaser ultimately uses or receives the benefit of what was purchased shall be paramount in determining the proportion of the benefit in this state to the benefit everywhere.”

27. Other States’ Provisions • Mich. Rev. State. Sec. 208.1305(2) • “The receipts are included in the numerator of the apportionment factor in proportion to the extent that the recipient receives benefit of the services in this state.”

28. Other States’ Provisions • Ga. Rev. Stat. Sec. 48-7-31(d)(2)(C) • “Gross receipts are in this state if the receipts are derived from customers within this state or if the receipts are otherwise attributable to this state's marketplace.”

29. Other States’ Provisions • Wis. Rev. Stat. Sec. 71.25(9)(dh)(1)-(4) • “Gross receipts from services are in this state if the purchaser of the service received the benefit of the service in this state. • The benefit of a service is received in this state if any of the following applies: • The service relates to real property that is located in this state. • The service relates to tangible personal property that is located in this state at the time that the service is received or tangible personal property that is delivered directly or indirectly to customers in this state. • The service is provided to an individual who is physically present in this state at the time that the service is received. • The service is provided to a person engaged in a trade or business in this state and relates to that person's business in this state. • If the purchaser of a service receives the benefit of a service in more than one state, the gross receipts from the performance of the service are included in the numerator of the sales factor according to the portion of the service received in this state. • If the taxpayer is not subject to income tax in the state in which the benefit of the service is received, the benefit of the service is received in this state to the extent that the taxpayer's employees or representatives performed services from a location in this state. Fifty percent of the taxpayer's receipts that are considered received in this state under this paragraph shall be included in the numerator of the sales factor. “

30. Dispositions of Business Assets and Interests in Entities • Sale of assets of a business • Comprised of different types of assets, each of which may have a different sourcing method • Inventory • Fixed assets • Intangibles • Sale of stock and other interests in entities • Corporations • Partnership entities

31. Taxpayer Issues • Changing Business Facts • Administrative Burdens • Loss of Documents/Support • Changing/Reduced Staff • No Historical Knowledge • No Budget

32. Questions? • Which of these issues relates to your business?

33. Circular 230 Disclosure • CIRCULAR 230 DISCLOSURE - To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (2) promoting, marketing or recommending to another party any transaction, arrangement or other matter.