Taxpayer Victory In South Carolina 'Bifurcated' Apportionment Case

The South Carolina Court of Appeals, in an opinion released today, ruled in favor of the taxpayer in CarMax Auto Superstores West Coast, Inc. v. South Carolina Department of Revenue, Opinion No. 4953 (March 14, 2012). The Court of Appeals ruled that where the SC Department of Revenue ("Department") seeks to deviate from the standard method of apportionment, the Department – and not the taxpayer – bears the burden of proving that (1) the standard method should not be used and (2) the alternative method is reasonable and is more appropriate than any competing method.

A copy of the court's opinion can be accessed here.

Reed Smith participated in the case, on behalf of the Council on State Taxation, as amicus curiae.

Background

CarMax Auto Superstores West Coast, Inc. ("Taxpayer") is a retailer of used light trucks and automobiles, and operates CarMax retail locations in several Western states, including California, Utah, and Nevada. CarMax Auto Superstores, Inc. ("East") is a related entity that operates CarMax retailers in several Eastern states, including South Carolina. Also, prior to 2004, East handled financing and corporate overhead/management.

The transactions at issue in the case involved an "East-West" structure. Prior to 2004, and in addition to its retail activities, Taxpayer held and managed certain intangible property ("IP"). Taxpayer licensed the use of the IP to East, in exchange for a royalty fee payment. East regularly filed South Carolina corporate income tax returns and received a deduction against its income for royalty and other payments to Taxpayer. In 2004, the Taxpayer's corporate structure was reorganized. As a result, the financing operations and ownership of the intellectual property were moved to CBS. Taxpayer and East paid a management services fee, which included a royalty component, to CBS.

On audit, the Department contended that the Taxpayer's returns failed to reflect fairly the extent of the Taxpayer's business in South Carolina. To correct this perceived distortion, the Department essentially bifurcated Taxpayer into two separate entities – an intangibles licensing company and a company that conducted the rest of Taxpayer's retail sales business. To accomplish this, the Department utilized an alternative apportionment method. The Taxpayer's income from royalties and financing was apportioned to South Carolina using a ratio of the Taxpayer's receipts from royalties and financing from within South Carolina by...