Apportionable and Nonapportionable Income Defined
This rule adopts a model regulation recommended by the Multistate Tax Commission to promote uniform treatment of this item by the states. This rule applies to tax years beginning on or after January 1, 2018.
Apportionment and Allocation. ORS 314.610 (Definitions for ORS 314.605 to 314.675)(1) and (5) require that every item of income be classified either as apportionable income or nonapportionable income. Income for purposes of classification as apportionable or nonapportionable includes gains and losses. Apportionable income is apportioned among jurisdictions by use of a formula. Nonapportionable income is specifically assigned or allocated to one or more specific jurisdictions pursuant to express rules. An item of income is classified as apportionable income if it falls within the definition of apportionable income. An item of income is nonapportionable income only if it does not meet the definitional requirements for being classified as apportionable income.
Apportionable Income. Apportionable income means all income that is apportionable under the Constitution of the United States and is not allocated under the laws of this state, including:
Income arising from transactions and activity in the regular course of the taxpayer’s trade or business; and
Income arising from tangible and intangible property if the acquisition, management, employment, development or disposition of the property is or was related to the operation of the taxpayer’s trade or business; and
Any income that would be allocable to this state under the Constitution of the United States, but that is apportioned rather than allocated pursuant to the laws of this state. The classification of income by the labels occasionally used, such as manufacturing income, compensation for services, sales income, interest, dividends, rents, royalties, gains, income derived from accounts receivable, operating income, non-operating income, etc., is of no aid in determining whether income is apportionable or nonapportionable income.
“Trade or business,” as used in the definition of apportionable income and in the application of that definition means the unitary business of the taxpayer, part of which is conducted within Oregon.
Transactional Test. Apportionable income includes income arising from transactions and activity in the regular course of the taxpayer’s trade or business.
If the transaction or activity is in the regular course of the taxpayer’s trade or business, part of which trade or business is conducted within Oregon, the resulting income of the transaction or activity is apportionable income for Oregon. Income may be apportionable income even though the actual transaction or activity that gives rise to the income does not occur in Oregon.
For a transaction or activity to be in the regular course of the taxpayer’s trade or business, the transaction or activity need not be one that frequently occurs in the trade or business. Most, but not all, frequently occurring transactions or activities will be in the regular course of that trade or business and will, therefore, satisfy the transactional test. It is sufficient to classify a transaction or activity as being in the regular course of a trade or business, if it is reasonable to conclude transactions of that type are customary in the kind of trade or business being conducted or are within the scope of what that kind of trade or business does. However, even if a taxpayer frequently or customarily engages in investment activities, if those activities are for the taxpayer’s mere financial betterment rather than for the operations of the trade or business, such activities do not satisfy the transactional test. The transactional test includes, but is not limited to, income from sales of inventory, property held for sale to customers, and services which are commonly sold by the trade or business. The transactional test also includes, but is not limited to, income from the sale of property used in the production of apportionable income of a kind that is sold and replaced with some regularity, even if replaced less frequently than once a year.
Functional test. Apportionable income also includes income from tangible and intangible property, if the acquisition, management, employment, development, or disposition of the property is or was related to the operation of the taxpayer’s trade or business. “Property” includes any direct or indirect interest in, control over, or use of real property, tangible personal property and intangible property by the taxpayer. Property that is “related to the operation of the trade or business” refers to property that is or was used to contribute to the production of apportionable income directly or indirectly, without regard to the materiality of the contribution. Property that is held merely for investment purposes is not related to the operation of the trade or business. “Acquisition, management, employment, development or disposition” refers to a taxpayer’s activities in acquiring property, exercising control and dominion over property and disposing of property, including dispositions by sale, lease or license. Income arising from the disposition or other utilization of property which was acquired or developed in the course of the taxpayer’s trade or business constitutes apportionable income, even if the property was not directly employed in the operation of the taxpayer’s trade or business. Income from the disposition or other utilization of property which has been withdrawn from use in the taxpayer’s trade or business and is instead held solely for unrelated investment purposes is not apportionable. Property that was related to the operation of the taxpayer’s trade or business is not considered converted to investment purposes merely because it is placed for sale, but any property which has been withdrawn from use in the taxpayer’s trade or business for five years or more is presumed to be held for investment purposes.Example 1: Taxpayer purchases a chain of 100 retail stores for the purpose of merging those store operations with its existing business. Five of the retail stores are redundant under the taxpayer’s business plan and are sold six months after acquisition. Even though the five stores were never integrated into the taxpayer’s trade or business, the income is apportionable because the property’s acquisition was related to the taxpayer’s trade or business.Example 2: Taxpayer is in the business of developing adhesives for industrial and construction uses. In the course of its business, it accidentally creates a weak but non-toxic adhesive and patents the formula, awaiting future applications. Another manufacturer uses the formula to create temporary body tattoos. Taxpayer wins a patent infringement suit against the other manufacturer. The entire damages award, including interest and punitive damages, constitutes apportionable income.Example 3: Taxpayer is engaged in the oil refining business and maintains a cash reserve for buying and selling oil on the spot market as conditions warrant. The reserve is held in overnight “repurchase agreement” accounts of U.S. treasuries with a local bank. The interest on those amounts is apportionable income because the reserves are necessary for the taxpayer’s business operations. Over time, the cash in the reserve account grows to the point that it exceeds any reasonably expected requirement for acquisition of oil or other short-term capital needs and is held pending subsequent business investment opportunities. The interest received on the excess amount is nonapportionable income.Example 4: A manufacturer decides to sell one of its redundant factories to a real estate developer and transfers the ownership of the factory to a special purpose subsidiary, SaleCo (Taxpayer) immediately prior to its sale to the real estate developer. The parties elect to treat the sale as a disposition of assets under IRC 338(h)(10), resulting in Taxpayer recognizing a capital gain on the sale. The capital gain is apportionable income.
Under the functional test, income from the disposition or other utilization of property is apportionable if the property is or was related to the operation of the taxpayer’s trade or business. This is true even though the transaction or activity from which the income is derived did not occur in the regular course of the taxpayer’s trade or business.
Income that is derived from isolated sales, leases, assignments, licenses, and other infrequently occurring dispositions, transfers, or transactions involving property, including transactions made in the full or partial liquidation or the winding-up of any portion of the trade or business, is apportionable income, if the property is or was related to the taxpayer’s trade or business. Income from the licensing of an intangible asset, such as a patent, copyright, trademark, service mark, know-how, trade secrets, or the like, that was developed or acquired for use by the taxpayer in its trade or business, constitutes apportionable income whether or not the licensing itself constituted the operation of a trade or business, and whether or not the taxpayer remains in the same trade or business from or for which the intangible asset was developed or acquired.
Under the functional test, income from intangible property is apportionable income when the intangible property serves an operational function as opposed to solely an investment function.
If the acquisition, management, employment, development, or disposition of the property is or was related to the operation of the taxpayer’s trade or business, then income from that property is apportionable income even though the actual transaction or activity involving the property that gives rise to the income does not occur in Oregon.Example 5: A manufacturer purchases raw materials to be incorporated into the product it offers for sale. The nature of the raw materials is such that the purchase price is subject to extreme price volatility. In order to protect itself from extreme price increases (or decreases), the manufacturer enters into future contracts pursuant to which the manufacturer can either purchase a set amount of the raw materials for a fixed price, within a specified time period, or resell the future contracts. Any gain on the sale of the future contracts would be considered apportionable income, regardless of whether the contracts were either made or resold in Oregon.Example 6: A national retailer produces substantial revenue related to the operation of its trade or business. It invests a large portion of the revenue in fixed income securities which are divided into three categories; (a) short-term securities held pending use of the funds in the taxpayer’s trade or business; (b) short-term securities held pending acquisition of other companies or favorable developments in the long-term money market, and (c) long-term securities held as an investment. Interest income on the short-term securities held pending use of the funds in the taxpayer’s trade or business (a) is apportionable because the funds represent working capital necessary to the operations of the taxpayer’s trade or business. Interest income derived from the other investment securities (b) and (c) is not apportionable as those securities were not held in furtherance of the taxpayer’s trade or business.
If with respect to an item of property a taxpayer (i) takes a deduction from income that is apportioned to Oregon or (ii) includes the original cost in the property factor, it is presumed that the item or property is or was related to the operation of the taxpayer’s trade or business. No presumption arises from the absence of any of these actions.
Application of the functional test is generally unaffected by the form of the property (e.g., tangible or intangible property, real or personal property). Income arising from an intangible interest, as, for example, corporate stock or other intangible interest in an entity or a group of assets, is apportionable income when the intangible itself or the property underlying or associated with the intangible is or was related to the operation of the taxpayer’s trade or business. Thus, while apportionment of income derived from transactions involving intangible property may be supported by a finding that the issuer of the intangible property and the taxpayer are engaged in the same trade or business, i.e., the same unitary business, establishment of such a relationship is not the exclusive basis for concluding that the income is subject to apportionment. It is sufficient to support the finding of apportionable income if the holding of the intangible interest served an operational rather than an investment function.
Relationship of transactional and functional tests to U.S. Constitution. The Due Process Clause and the Commerce Clause of the U.S. Constitution restrict states from apportioning income that has no rational relationship with the taxing state. The protection against extra-territorial state taxation afforded by these Clauses is often described as the “unitary business principle.” The unitary business principle requires apportionable income to be derived from the same unitary business that is being conducted at least in part in Oregon. The unitary business that is conducted in Oregon includes both a unitary business that the taxpayer alone may be conducting and a unitary business the taxpayer may conduct with any other person or persons. Satisfaction of either the transactional test or the functional test complies with the unitary business principle, because each test requires that the transaction or activity (in the case of the transactional test) or the property (in the case of the functional test) be tied to the same trade or business that is being conducted within Oregon. Determination of the scope of the unitary business being conducted in Oregon is without regard to the extent to which Oregon requires or permits combined reporting.(8) Nonapportionable income. Nonapportionable income means all income other than apportionable income.