South Carolina Supreme Court Holds Party Proposing Alternative

The South Carolina Supreme Court has affirmed the Court of Appeals' holding that the party proposing the use of an alternative apportionment method has the burden of proof.1 Specifically, the moving party must prove by a preponderance of the evidence that: (i) the statutory formula does not fairly represent the taxpayer's business activity in the state; and (ii) its alternative method is reasonable. In reaching its decision, the Supreme Court disagreed with the Court of Appeals that the moving party is further required to satisfy the second part of the test by proving that the alternative formula more fairly represents the taxpayer's business activity in the state. Furthermore, the Court of Appeals misapplied Media General Communications, Inc. v. Department of Revenue2 by requiring the moving party to prove that the alternative formula is more reasonable than any competing methods.

Background

CarMax, Inc. (CarMax), the nation's largest retailer of used cars and light trucks, operated prior to 2004 as a holding company with two wholly owned subsidiaries: (i) CarMax West, which sold used vehicles in the western United States and owned substantially all of CarMax's intellectual property; and (ii) CarMax East, which sold used vehicles in the eastern and midwestern United States, including South Carolina. CarMax East paid CarMax West a royalty for its use of the intellectual property.

In 2004, CarMax's corporate structure was reorganized. CarMax Business Services, LLC (CBS) was created to: (i) house CarMax's financing operations, CarMax Auto Finance (CAF); (ii) provide certain shared services to the companies in the group; and (iii) own the intellectual property. CBS was created as a limited liability company with CarMax West owning a 93.5 percent interest and CarMax East owning the remaining 6.5 percent interest. CBS charged CarMax West and CarMax East a per vehicle management services fee, which included an intellectual property royalty component. The income from the management fee, in addition to the financing income generated through CAF, was distributed to CarMax West and CarMax East based on their ownership percentages. As a result, CarMax West had South Carolina source income after 2004 even though it did not have any retail operations in South Carolina.3

CarMax West filed South Carolina corporate income tax returns for the years 2002-2007 utilizing the standard three-factor apportionment formula.4 After auditing CarMax West, the Department adjusted the apportionment formula because in its view, neither the standard formula nor the...