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July 24, 2014
Sales-Factor Apportionment of Profits to Broaden the Tax Base
by Michael Udell and Aditi Vashist

Full Text Published by Tax Analysts®

This document originally appeared in the July 15, 2014 edition of Tax Notes Today.


Michael Udell and Aditi Vashist work for District Economics Group. The authors thank Reuven Avi-Yonah, Pat Driessen, Elliott Dubin, Michael Durst, Jane Gravelle, Martin Lobel, Walter Minnick, Bill Parks, Martin Sullivan, and Eric Toder for their helpful comments.

In this report, Udell and Vashist argue that a single-sales-factor apportionment of global profits could redefine the corporate income tax base. Using financial statements and tax return data for 2010, they show that a single-sales-factor apportionment of global profits could, on a static basis, result in a U.S. corporate income tax base up to 97 percent larger than the current base, with greater transparency and improved reporting incentives. Corporate tax revenues could range from 13 to 169 percent larger than the current tax liability after credits, with revenue-neutral tax rates between 31 and 13 percent, respectively. The resulting U.S. corporate income tax system could accommodate lower rates, ease administrative burdens for taxpayers and tax administrators, and raise at least as much revenue as the current system.

A more in-depth analysis is available at http://www.districteconomics.com/papers/USsalesfactorapportionment.pdf.


* * * * *

Table of Contents

I. Introduction

    A. Corporate Profits and Tax Liability

    B. Information


II. Formulary Apportionment of Global Profits

    A. Unitary Business

    B. Apportionment Formula

    C. Sales-Factor Apportionment


III. Discussion

    A. Unitary Business

    B. Formulary Apportionment

    C. Tax Avoidance Concerns


IV. Conclusion

I. Introduction

The corporate income tax is a costly and inefficient way to raise revenue. Although the tax remains an essential part of the federal income tax system, accounting for $223 billion (19 percent) of the $1,174 billion of liability reported in 2010 (not including payroll and other taxes), only $30 billion (2 percent) is from foreign-source earnings.1 While much attention has focused on the taxation of foreign-source income, an equally large problem is the approximately $250 billion annual understatement in domestic corporate profits on tax returns, which benefits U.S. multinational corporations over their purely domestic counterparts.2

Both the lack of federal tax revenue from foreign-source earnings and the understatement of domestic corporate profits arise because, unlike the wage-based individual income and employment tax liabilities, it is difficult to verify corporate income tax liability. That difficulty causes the tax authority to engage in lengthy, costly, and contentious audits and disagreements with corporate taxpayers.3 And because the tax liability amounts at issue can be large, tax authorities have taken administrative actions to induce greater clarity in the reporting of income. Advance pricing agreements,4 required reporting of uncertain tax positions,5 litigation around tax accrual workpapers, and burdensome proposed regulations on transfer pricing6 are all symptomatic of a tax system that challenges both taxpayers and tax authorities to determine corporate income tax liability.

That may seem surprising given that the corporate income tax is a tax on corporate profits and that corporate profits (at least for publicly traded corporations, which pay the bulk of corporate income tax) are freely broadcast to anyone with a television set or Internet connection as part of quarterly financial statement releases. But corporate profits are difficult to verify. That is because the corporate profit measures required by regulators and used by investors to understand the economic performance of a business are not the same corporate profits used to determine corporate income tax liability.7 If they were the same, corporate tax receipts would increase significantly, corporate tax liability shown on tax returns would be greater, there would be less litigation around corporate tax liability, and the corporate tax rate would likely be lower than it is today while achieving equal if not greater revenue.

A single-sales-factor apportionment of global profits, as an alternative construction of a corporate income tax base, could address both the underreporting of domestic corporate profits and the uneconomic location of permanently reinvested earnings overseas, which results in little tax paid on foreign-source earnings. Using 2010 data, we show that an alternative definition of a corporate tax base using a sales factor apportionment of global profits could be as much as 97 percent larger on a static basis than the current tax base. That tax base can be more transparent by design and less costly to comply with, both for taxpayers and the tax authority.

We argue that sales factor apportionment of global profits would at least partially solve the problem of asymmetric information in the reporting of tax liability by multinational corporations, which results in understated income. That problem has largely been addressed in the individual income tax through the evolution of three-party information reporting systems. The benefits of three-party information reporting that would accompany the adoption of a sales factor apportionment system should be carefully considered, along with some of the challenges posed by sales factor apportionment.

A. Corporate Profits and Tax Liability

There is a disconnect between the size and growth of corporate profits shown on the financial statements of U.S.-domiciled multinational corporations and the relatively modest amounts of corporate profits and tax liability reported on the income tax returns of those companies. Measuring the amount of underreported corporate profits on income tax returns is difficult because the returns are not publicly disclosed, but various indirect approaches have arrived at remarkably similar estimates. Kimberly A. Clausing used an econometric specification to estimate the size of unreported corporate profits on 2008 tax returns at $256 billion,8 while the Bureau of Economic Analysis (BEA) relied on IRS audit adjustment information to estimate unreported profits of $286 billion for the same year.9 Reuven S. Avi-Yonah, Clausing, and Michael C. Durst used BEA data on domestic and international profitability of U.S. corporations for 2005 and estimated underreporting of $285 billion.10 Also using BEA data, we estimate that corporate profits for 2010 were understated on corporate income tax returns by approximately $264 billion.

The understatement of profits is achieved through transfer pricing, APAs, cost-sharing agreements, interest allocation arrangements, the check-the-box regulations, and the controlled foreign corporation look-through rules, all of which effectively unhinge profits from either the source of the economic activity or the domicile of the corporation by manipulating the separate accounting of income that underlies the corporate income tax.11 While worldwide profits of a multinational corporation remain unaffected, high-tax jurisdictions end up with lower profits, and low-tax jurisdictions end up with higher profits.12 As a result, domestic tax bases in high-tax jurisdictions like the United States are reduced while foreign tax bases in low-tax jurisdictions are increased.13

Understated domestic profits on corporate income tax returns are only the first of two challenges for the corporate tax. The second is that the residual U.S. corporate tax liability on foreign-source income reported on U.S. returns is calculated using a tax rate that is roughly one-fifth of the rate that applies to domestic profits, as shown in Table 1. These two challenges place purely domestic companies at a competitive disadvantage compared with multinational corporations. While tax policymakers have been concerned about them for decades, these two problems persist.

How significant are these challenges? In 2010, of the roughly $1 trillion in taxable income, $439 billion was foreign-source and $583 billion was U.S.-source. Of the $223 billion in corporate income taxes paid, about $30 billion was attributable to foreign-source income, and the remaining $193 billion was attributable to U.S.-source income.14

                Table 1. Taxable Income, Liability, and
       Average Rate for Corporate Income Tax Returns, 2008-2010
                            ($ in billions)
 ______________________________________________________________________

                                          2010       2009      2008
 ______________________________________________________________________

 Income subject to tax
 (less REITs and RICs)                   $1,022      $895      $978

      Foreign taxable income*              $439      $404      $373

      Domestic taxable income              $583      $490      $605

 Income tax before credits                 $355      $310      $340

 Net income tax                            $223      $205      $229

      From foreign income                   $30       $30       $22

      From domestic income                 $193      $175      $206

 Effective average federal tax rate

      On foreign income                      7%        7%        6%

      On domestic income                    33%       35%       34%
 ______________________________________________________________________

                              FOOTNOTE TO TABLE 1

      * Foreign taxable income calculated as the sum of subpart F
 income and repatriated earnings and profits of related foreign
 corporations, foreign branch income of U.S. parents, dividends
 received from foreign corporations and rents and royalties from
 foreign corporations.

                           END OF FOOTNOTE TO TABLE 1

 Sources: IRS Statistics of Income, "Corporation Source Book,"
 2008-2010 and Form 1118, 2008-2010.

Thus, about 7 percent of the U.S. corporate income tax paid in 2010 was attributable to foreign-source income, while 43 percent of corporate income reported on tax returns was foreign-source.

B. Information

1. Information and efficient tax administration. The unhinging of profits from the corporate income tax base is facilitated by a two-party information reporting system that creates inefficient tax administration. Efficient tax administration is the bedrock of tax compliance and ultimately of the fairness of the tax system. Large amounts of tax revenue are at stake. One hallmark of efficient tax administration is the ease with which liability can be verified and the resulting low cost of compliance. The easier it is for the tax authority to verify liability, the more costly it is for the taxpayer to embark on tax avoidance.

The essential feature of efficient three-party information reporting for tax administration is the presence of an interest between two of the parties -- the taxpayer and a third party that is not the tax authority -- in an amount that can be used by the tax authority to easily verify income or liability. For the three-party wage-based system, employers want to report high amounts of wages to support their deduction, while employees would like a smaller amount reported so they may pay less income tax. When the tax authority can exploit the presence of that interest, as the IRS does with employer-reported amounts of wages on a Form W-2, tax administration is more efficient because less effort is required to verify the reported amounts and taxpayers spend fewer resources in post-filing audits and litigation. Table 2 shows the benefits in tax administration for a well-designed, efficient, three-party information system.

In the absence of three-party information reporting, the tax authority must audit the taxpayer to verify income. The two-party exchange of information between the taxpayer and the tax authority lacks an interest between the taxpayer and a third party to report amounts that the tax authority can use to verify tax liability. Two-party information reporting often results in the strategic understatement of income by taxpayers, the extent of which is largely governed by the tax penalty regime and the tax authority's willingness and budget capacity to challenge taxpayer-reported amounts.

This occurs regardless of the taxpayer entity. For example, sole proprietors conducting business only in the United States understate business income by not reporting gross receipts because that is the most difficult noncompliance for the tax authority to detect -- resulting in net misreporting of business income by 56 percent compared with 1 percent for wage income.15 Multinational corporations do not understate income by underreporting receipts as sole proprietors do, because it is easy for the tax authority to verify receipts. Most multinationals are not paid in cash like most noncompliant sole proprietors are. Instead, when multinationals understate income, it is through a variety of adjustments to receipts driven by the separate accounting of profits. The tax authority does not use an amount reported by the multinational taxpayer to another party, like shareholders, to verify income. Additionally, the adjustments to income required by separate accounting of profits are not shared with a third party. Instead, income verification rests with an increasingly budget-constrained tax authority.

Table 2, a snapshot of 2010 reported tax liability and audit measures, demonstrates the impact of three-party (wage-based individual income tax system) and two-party (corporate income tax system) reporting on tax compliance. The tax audit measures of additional tax and penalties recommended and unagreed -- meaning that the taxpayer disagreed with the assessment and will contest it through administrative appeals and eventually through the courts -- are for pre-2010 tax years. Three-party information systems are appropriately designed like the wage-based system when they drive the taxpayer and the tax authority to the same measure of liability and reduce conflict and expense for both parties.

 Table 2. Tax Compliance of Three- and Two-Party Information Reporting Systems
                            For Federal Taxes, 2010
                                ($ in billions)
 ______________________________________________________________________________

                                                    Additional
                                                    Tax and
                                     Additional     Additional    Penalties
                                     Tax and        Tax and       Unagreed as a
                   Reported          Penalties      Penalties     Percentage of
                   Tax Liability     Recommended    Unagreed by   Reported Tax
                   After Credits     During 2010    Taxpayer      Liability
 ______________________________________________________________________________

 Three-party
 wage-based
 individual
 system*              $1,531             $7.3           $1.6         0.1%

 Two-party
 corporate
 income tax             $223            $26.2          $17.9         8.0%
 ______________________________________________________________________________

                              FOOTNOTE TO TABLE 2

      * The wage-based individual system is the sum of $860 billion of
 employment tax liability plus $671 billion of individual income tax liability
 associated with wage income determined using Statistics of Income Individual
 Income Tax Table 1.4 for Tax Year 2010. Additional tax and penalties and
 unagreed amounts are from Tables 9a and 10 of the IRS 2010 Data Book. Audit
 recommended and unagreed amounts pertain to multiple tax years prior to 2010
 that were under audit during 2010.

                           END OF FOOTNOTE TO TABLE 2

 Sources: IRS Data Book, 2010, DEG calculations of wage-based system from SOI
 Individual Income Tax Returns for Tax Year 2010 Table 1.4, and Corporate
 Income Tax Returns for Tax Year 2010 Corporate Source Book.

Not all three-party information reporting systems result in efficient tax administration. The pre-FATCA qualified intermediary regime, which was intended to address understatements of income by U.S. persons with overseas financial accounts, failed to induce truthful three-party reporting that the tax authority could use to verify income. The reason was that the QI's and the taxpayer's interests were aligned in underreporting income.

Economists have generally not recognized the poor dynamics of two-party information systems as a cause of the substantial underreporting of corporate income on tax returns. Recommended tax adjustments in the corporate income tax were approximately 12 percent of reported net liability in 2010 ($26.2/$223) but only 0.5 percent of reported net liability for the wage-based system ($7/$1,531) -- proportionately 24 times smaller. Worse, tax adjustments challenged by corporate taxpayers were approximately 8 percent of reported net liability in 2010 but only 0.1 percent of reported net liability for the wage-based system -- proportionately 80 times smaller. By abstracting away the potential tax system benefits of three-party information reporting, comparisons with two-party reporting for separate accounting tax schemes understate the support for the tax base that formulary apportionment can provide.16

2. Information and corporate profits. For the current corporate income tax, no third party has an interest in the amounts of taxable income reported that can be used by the tax administrator to verify amounts reported by the taxpayer.17 As Edward D. Kleinbard wrote in describing the tax liability of Starbucks Corp. in the United Kingdom, "The Starbucks story -- in particular, its U.K. experience -- demonstrates the fundamental opacity of international tax planning, in which neither investors in a public firm nor the tax authorities in any particular jurisdiction have a clear picture of what the firm is up to."18 The opacity that Kleinbard refers to is not necessarily a symptom of bad corporate actors, but rather the outcome of poorly designed two-party information reporting.

3. Finding a third party. For publicly traded corporations, shareholders could be a third party. To judge their investment decisions, shareholders need, and are provided with, a set of standardized metrics of corporate profits that conveys the financial results of corporate activities. Shareholder interest in increasing profits can be used by the tax authority to help verify reported profits used to determine tax liability.

4. Not local profits. Shareholder and tax authority interests could be aligned if the tax authority could use worldwide profits to determine domestic tax liability -- the same profits measure that shareholders use to value their investment. Shareholders want high profits, and tax authorities want accurate reporting of income. Just as corporations want to report all wage and salary payments to support their deduction claims, corporations want to report profits to shareholders to support their continued investment in the business. This incentive could be the reinforcing third-party information reporting mechanism that is absent from the current corporate income tax system. The attendant benefits of a reinforcing information reporting system are clear for tax administration: More liability is voluntarily reported, and less effort is required to verify liability, as Table 2 shows.

If the tax authority could use global profits reported on financial statements as the basis for determining U.S. corporate income tax liability, that might be the end of the story. Tax authorities can use global profits of a unitary business as part of a formula to determine tax liability, as both Container Corp. of America v. Franchise Tax Board19 and Barclays Bank PLC v. Franchise Tax Board of California20 established. However, a tax authority cannot rely solely on global profits without potentially running afoul of the permanent establishment clause in article 5 of all U.S. tax treaties, because some portion of global profits might be unrelated to economic activity within the tax authority's jurisdiction. While recognizing that recent tax reform proposals by House Ways and Means Committee Chair Dave Camp, R-Mich.,21 and former Senate Finance Committee Chair Max Baucus,22 have sought to extend the corporate income tax for U.S.-domiciled multinationals on a unitary business even when a CFC of the business has sales but no PE in the United States, some means to apportion global profits is needed.23


II. Formulary Apportionment of Global Profits

A. Unitary Business

To preserve the benefit of using shareholders as a third party, formulary apportionment of global profits would require combined reporting of income for a unitary business rather than separate reporting for each of its entities. That is because the interest in profits that management will respond to is at the unitary level.24 Not all approaches to defining a unitary business include a third party with both access to, and an intrinsic interest in, information from the taxpayer that the tax authority could also use to verify liability. For example, the federal income tax relies on section 482 rules to define a unitary basis by determining direct or indirect control of a business, but those rules do not use a third party that has an intrinsic interest in business profits.25 Instead, section 482 rules construct profit measures to which no one other than the taxpayer (and its agents hired to construct the transfer prices) and the tax authority have access. By making transfer pricing information and documentation private, the section 482 rules essentially preclude the existence of an interested third party that the tax authority could use to aid in the verification of tax liability.

The tax base we construct follows financial statement reporting requirements as described in International Financial Reporting Standards 10, "Consolidated Financial Statements," which focus on control to define a unitary business but, more importantly, focus on control by investors.26 As IFRS 10 states, "An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee."

The profit measure used to construct the tax base should not be based on the separate profits of disparate economic entities within a unitary business but on the profits of shareholders as equity investors in the combined activities of the unitary business.27 When shareholders become disenchanted with a particular line of business that the combined business undertakes, they encourage management to act, either by voting as shareholders or by buying or selling their shares in the business. The tax authority should be able to determine tax liability by using the fundamental dynamic of management trying to appease shareholders by increasing profits. This would result in efficient tax administration and improved corporate tax compliance.

B. Apportionment Formula

From an investor perspective, neither the domicile or source concepts used to allocate profits for tax purposes are particularly relevant to the valuation of a business. On investor earnings calls, the focus is on sales and on which markets a business is increasing or contracting in. Investors will take management to task for declining sales and reward management for growing sales, and it is this management-investor relationship that can be beneficial to tax administration. Investors will exert less pressure on management along the other dimensions of plant, payroll, and headquarters location because, as James R. Hines shows, the connection to profits is less clear.28 However, we acknowledge that management's incentive to increase sales may not provide perfect support for increasing sales in a particular location, especially when sales carry a greater tax burden. In a sales factor apportionment of global profits tax system, one tax planning goal of efficient supply chain management would be to reduce the appearance of sales in high-tax jurisdictions without actually reducing sales. We return to this tax avoidance issue in Part III.

The allocation of worldwide profits to jurisdictions must rely on second-best or imprecise measures because there are no clear formulae for allocating value geographically.29 The Multistate Tax Commission, Walter Hellerstein, Durst, and others have led an extensive legal development and economic analysis of formulary apportionment schemes and incentives for state taxation in the United States. Their work has explored a complete revision of the model statute for formulary apportionment schemes, rules that address instances when formulary apportionment results in unfair taxation, and the resolution of disputes.30 The trend among states has been to adopt destination-based single-sales-factor apportionment as an inducement for corporations to locate plants and payroll there, and to use source-based factors such as property and payroll only when the sales factor alone would result in an unfair apportionment of income.31

Most states have used an allocation mechanism that first defines profits to the "water's edge" of the United States and then applies a version of the three-factor apportionment formula to each state's share of those profits. Some states have begun to challenge the water's-edge construct by including income from foreign affiliates in their state apportionment formulas. Montana and Oregon list countries that have foreign affiliates of corporations doing business in those states; and Alaska, West Virginia, and the District of Columbia require income from controlled foreign affiliates in tax havens to be included in the tax base.32 The EU, in considering the common consolidated corporate tax base, follows the U.S. states' experience by first defining a water's edge as the 27 member states of the EU and then apportioning financial statement profits among member states by a four-factor formula using sales, employees, payroll, and assets. Even when sales are used to apportion income, investor and tax administrator interests cannot be aligned under a water's-edge apportionment scheme unless the unitary business is inside the boundary. Water's-edge accounting for profits is simply another variation on separate accounting and shares the same poor incentives for reporting liability that occur with two-party information reporting schemes. In brief, investors don't care about the water's-edge measurement of profits.

C. Sales-Factor Apportionment

1. A broader tax base. Using annual financial statement data for U.S.- and foreign-domiciled corporations for 2010, we construct an ideal corporate income tax base from global profits of all the members of a commonly controlled investor group, apportioned by sales in the United States.33 Global profits are defined as revenues less the sum of cost of goods sold, selling, general and administrative expenses (including research and development costs), and depreciation and amortization. This pretax, pre-interest expense, pre-other-income definition of a tax base is shown in Table 3. Table 4 will account for interest expense and other income separately. We focus on C corporations from 14 industries that account for the largest amount of 2010 corporate business receipts reported in the IRS Statistics of Income data: petroleum manufacturers; pharmaceutical manufacturers; other chemical manufacturers; computer and electronic equipment manufacturers; transportation manufacturers; mining companies; insurance companies; retail trade companies; wholesale trade companies; information companies; professional, scientific, and technical services companies; construction companies; accommodation and food services companies; and healthcare and social assistance companies.34 We follow the practice of many U.S. states by excluding financial services (including banks, securities dealers, mutual funds, and real estate investment trusts) from sales factor apportionment of income.35 The financial statement sample includes 2,121 corporations. Of those, 1,883 were U.S.-domiciled (871 had domestic sales only, and 1,012 had domestic and foreign sales), and 238 were foreign-domiciled multinational corporations with U.S. sales.

           Table 3. Sales Factor Apportioned Global Profits
               For 2,121 Companies With U.S. Sales, 2010
                            ($ in billions)
 ______________________________________________________________________

     Item                   Total Sales             Global Profits
 ______________________________________________________________________

 Total sales                 $11,690                   $1,322
 U.S. sales                   $6,318                     $645
 Foreign sales                $5,372                     $677
 ______________________________________________________________________

 Source: Forms 10K and 20F annual financial statements for 2010.

2. Weighting financial statement profits. The $6,318 billion of U.S. sales accounts for 48 percent (or 53.8 percent when weighted by industry sales) of the $13,143 billion of business receipts reported on 2010 corporate income tax returns for the 14 industries in our sample. With the assumption that $1 of business receipts on tax returns is equivalent to $1 of sales on financial statements, we gross up the amount of U.S. apportioned global profits by 1/0.538 and estimate apportioned global profits as $645 billion x (1 x 0.538) = $1,199 billion for the 14 industries. Finally, these 14 industries accounted for 76 percent of business receipts for all corporate income tax returns (excluding financial services). Grossing up the U.S. apportioned global profits for the 14 industries to all corporations by (1/0.76) yields an estimate of apportioned global profits as $1,199 billion x (1/0.76) = $1,572 billion. This sales-factor-apportioned global profits tax base is 97 percent larger than the $798 billion of net income subject to tax reported for all corporations on 2010 returns (other than financial services).

Unlike the $798 billion of net income reported on tax returns, the $1,572 billion of U.S.-sales-apportioned global profits excludes foreign-source income. In 2010 these corporations reported income tax liability of $204 billion after tax credits. Because there is no need for foreign tax credits against a U.S.-sales-apportioned global profits tax base, each dollar of apportioned profit, whether from a domestic corporation with U.S. sales only or from a multinational with U.S. and foreign sales, would be subject to the same U.S. tax rate. On a static basis before compliance issues and behavioral responses by corporations, a 13 percent tax rate applied to $1,572 billion of sales-factor-apportioned global profits could result in the same $204 billion tax liability.

3. Some modifications to a single-sales-factor apportioned tax base. To demonstrate how policy options may reduce the $1,572 billion sales-factor-apportioned tax base, we consider four modifications shown in Table 4. First, from the financial statements, we apportion global interest expense by U.S. sales. Sales-factor-apportioned interest expense would amount to $259 billion. In contrast, on 2010 tax returns, approximately $650 billion in interest expense was reported, or more than twice as much as would have been allowed under a sales factor apportionment. Subtracting $259 billion of interest expense from the $1,572 billion sales factor tax base that remains reduces the tax base further to $1,313 billion.

     Table 4. Adjustments to Single-Sales-Factor Apportioned Global Profits
         Compared With $204 Billion Corporate Income Tax Liability for
             All Industries Other Than Financial Services, in 2010
                                ($ in billions)a
 ______________________________________________________________________________

                                                         Static        Static
                                                         Revenue at    Revenue
                              Amount of                  35 Percent    Neutral
       Item                   Adjustment    Tax Base     Rate          Rate
 ______________________________________________________________________________

 Single-sales-factor
 apportioned OIAD                            $1,572         $550        13.0%

 Less sales factor
 apportioned global
 interest expenseb             -$259         $1,313         $460        15.6%

 Less U.S. taxes
 paid (SOI)                    -$360           $953         $333        21.4%

 Less tax expenditures
 other than for
 foreign-source
 incomec                       -$291           $662         $232        30.9%

 Plus sales
 factor apportioned
 global passive
 incomed                         $52           $714         $250        28.6%
 ______________________________________________________________________________

                              FOOTNOTES TO TABLE 3

      a Net income on corporate income tax returns other than for financial
 services was $798 billion with after-tax credit liability of $204 billion
 which is used to estimate the revenue-neutral rate.

      b Sales factor apportioned global interest expense is from financial
 statements. Tax return amount of interest expense for all industries excluding
 financial services was $597 billion in 2010. Because factors of production are
 not included in the apportionment factor for global profits, they have not
 been included in the allocation of interest expense.

      c The tax expenditures excluded from this calculation are: inventory
 property sales source exception; deduction for foreign taxes paid instead of a
 credit; unavailability of symmetric worldwide method; apportionment of
 research and development expenses for determination of foreign tax credits;
 special rules for interest-charge domestic international sales corporations;
 deferral of active income of controlled foreign corporations; and deferral of
 active financing income.

      d Passive income defined as the difference between variables: pretax
 income and operating income after depreciation less interest expense, as
 reported in the Compustat database. Note that Compustat defines pretax Income
 to be OIAD less interest expense, plus non-operating income, plus interest
 income. Thus, estimated U.S. share of passive income from financial statements
 is the sales apportioned nonoperating and interest income reported on SEC
 filings.

                          END OF FOOTNOTES TO TABLE 3

A second modification would allow for a deduction for state and local taxes paid for these 14 industries. We use (state and local) taxes paid from tax return data rather than financial statement data due to inconsistent reporting, but recognize that this is a deviation from sales factor apportionment. In taxes paid, from 2010 tax returns would further reduce the sales factor tax base from $1,313 billion to $953 billion.

A third adjustment might be to allow all the current-law tax expenditures that benefit corporations. To estimate this amount, we use the Joint Committee on Taxation's tax expenditure estimates for 2010 and remove all the tax expenditures associated with foreign-source income or export benefits, since income from those activities would not be subject to tax. After removing those expenditures, there would have been $291 billion additional corporate tax base relating to corporate tax expenditures available to reduce the $953 billion tax base further to $662 billion. At a 35 percent tax rate, this tax base would yield $232 billion in revenue compared with $204 billion. A revenue-neutral tax rate would be approximately 30.9 percent.

A fourth and final adjustment would be to add to the tax base passive income reported on financial statements, such as rents, capital gains and losses, royalties, and interest, as well as losses carried forward. These worldwide amounts of passive income are apportioned to the United States using the sales factor and result in an increase of $52 billion, increasing the tax base from $662 billion to $714 billion. With the addition of the U.S. share of passive income, the tax rate necessary for revenue neutrality would be 29 percent.

Note that the Great Recession that began in 2007 is likely a key factor in the small estimate of passive income based on the financial statements sample. Of the 2,121 companies included in the financial statements sample across 14 industries, 1,030 (or 49 percent) reported losses from these sources of income. If 2007 data had been used for these analyses instead of 2010 data, the percentage of companies reporting passive losses would likely have been lower, and passive income would likely have been larger.

4. Some industry details. Table 5 provides industry detail of the financial statement data compared with corporate income tax returns. The top panel compares net income subject to tax from tax returns with the sales-factor-apportioned amounts of global profits for each industry before any of the adjustments to the tax base shown in Table 4. Because the financial statement data for public companies with assets less than $100 million in the aggregate show losses while corporate tax returns with assets under $100 million show profits, these data likely understate sales-factor-apportioned profits. Mining, retail trade, insurance, and transportation manufacturing all exhibit larger tax bases under sales-factor-apportionment than under current law. In what may be a surprise to some, the computer and electronics manufacturing industry shows very little adjustment under single-sales-factor apportionment of global profits, but as the bottom panel shows, the after-tax-credits liability is much less, indicating significant foreign-source income with low residual federal tax liability (see Table 1).

The second panel compares the number of filed tax returns with the number of financial statements of publicly traded companies used in the analysis of sales factor apportionment for each industry. The third panel shows the "coverage" of U.S. sales from these financial statements to business receipts reported on all C corporation tax returns. In general, a small number of companies account for a large portion of business receipts for many industries, but for at least one industry with very low coverage of business receipts -- the professional, scientific, and technical services industry -- public financial statements explain very little of industry sales.

The fourth panel compares the income tax liability calculated at 35 percent of net income subject to tax -- current-law income tax liability -- as reported on tax returns with the sales-factor-apportioned tax liability before any of the adjustments to the tax base shown in Table 4, calculated at 35 percent rate. The bottom row of this panel shows the net income tax liability after tax credits on tax returns. Because most tax credits are FTCs allowable on foreign-source income and foreign-source income would not be subject to tax under the sales factor apportionment of global profits, this bottom row reflects the small residual federal income tax liability from foreign-source income under the current system, as shown in Table 1.


III. Discussion

Single-sales-factor apportionment of global profits of a unitary business can be a useful approach for addressing several tax administration issues that have challenged lawmakers, tax administrators, and taxpayers. By defining the tax base at a unitary level, intercompany transactions, the allocation of shared resources, and the valuation of combined synergies (the very reason that a company would not outsource an activity) are rendered useless for tax avoidance. This occurs because corporate profits would be measured at an aggregate level that consolidates the current separation of these activities across taxing jurisdictions. Further, tax administration could be more efficient and taxpayer compliance costs could be reduced by defining the tax base using measures with intrinsic value to investors. However, formulary apportionment could create new challenges in the taxation of profits of multinational corporations. Some of those challenges are discussed below.

A. Unitary Business

Sales factor apportionment of global profits requires identifying a unitary business from which to allocate profits. Financial market regulators require information about businesses using capital markets to be publicly available so that investors can make informed decisions about the prospects for a business. We suggest that the definition of a unitary business follow these reporting requirements because they align closely with investor interests. The tax system should use information reported to investors for financial purposes, exploiting the alignment of investor and management interests to compel the taxpayer to report profits using the same metrics it uses in reporting to investors. While some may argue that defining a business for tax purposes by management control, using separate accounting, is a theoretically more correct measure of corporate profitability, practical experience shows that the current system results in significant misrepresentation of corporate profits. Policymakers should not let the perfect be the enemy of the good. Pursuit of the perfect has resulted in an annual understatement of corporate profits on income tax returns of at least $250 billion, which disproportionately ends up as the permanently reinvested earnings overseas of U.S. multinational corporations often located in jurisdictions with lower corporate effective tax rates.36

B. Formulary Apportionment

Sales factor apportionment of global profits, like the current corporate income tax, is a second-best solution to the taxation of corporate income. As with all second-best solutions, it is open to the criticism that it will only approximate the "correct" corporate income tax base. Apportioning global profits by sales ignores the varying levels of profitability among lines of businesses or markets that may exist within an enterprise, and it implicitly treats the profitability of each sale to be equal regardless of the location of the sale. However, transfer pricing and cost-sharing agreements effectively reduce the reported profitability of sales in locations with high corporate tax rates and increase reported profits in locations with low or no corporate tax.

Sales factor apportionment of global profits dispenses with the measurement of a conceptual liability, as required by separate accounting of profits, in favor of easily administrable and transparent concepts such as global profits, which can provide improved incentives to accurately report the tax base. It is not a perfect system, but when single-sales-factor apportionment of profits does not fit the facts of a particular economic activity, such as resource extraction, state tax systems have acknowledged this situation and promulgated rules to provide relief to more fairly reflect a taxpayer's income.37

C. Tax Avoidance Concerns

One benefit from using single-sales-factor apportionment is that corporate managers would not strategically reduce sales, since investors will hold them accountable for declining sales. However, investors might not hold them accountable for the strategic location of sales. This leads to what may be the biggest challenge to adopting a single-sales-factor apportionment of global profits: identifying the party with nexus for sales that occur in the United States but originate outside it. This report does not resolve the nexus problem, but the following example and discussion touch on the many authorities that exist to address this issue.

Assume that A, a U.S. company, manufactures a valuable product in Country X and the price of the product when sold in the United States includes an 80 percent profit margin. If Company A sold the product directly into the United States, both that sale and the 80 percent profit margin would be part of the single-sales-factor apportioned global profits tax base. Alternatively, assume Company A decides to sell the product first to unrelated Company B in Country X and that Company B then sells the product into the United States for the same price as before. To maintain the market price, Company A sells to Company B with 75 percent of the profit margin of the final sale price, and Company B sells into the United States with 5 percent of the profit margin of the final sale price. The same 80 percent profit is associated with the product, but now Company B has the sale into the United States and a 5 percent profit on the product, and Company A has a sale in Country X, not the United States, with a 75 percent profit on the product. U.S. consumers see no difference in prices, but Company A has lowered profitability of its sale to 75 percent in order to change the destination of its sale away from the United States. The result is that in the first case, a sale into the United States has an 80 percent profit margin, and in the second case, the same sale into the United States has a 5 percent profit margin. Should the sale into the United States with the 5 percent profit margin be respected for tax purposes, or should the offshore sale from Company A to Company B with the 75 percent profit margin be the sale for tax purposes? This is the nexus question in a nutshell. There are almost endless variations of this example, but all have the same outcome: unhinging profits that otherwise would be subject to U.S. tax.

The problem that sales factor apportionment of global profits resolves is the situation in which companies A and B are related and sales between them are across taxing jurisdictions. Under the current income tax, transfer pricing, cost-sharing, and inversion transactions are deployed to shift income between A and B. Under sales factor apportionment of global profits, those tools have no effect because profits are not measured across taxing jurisdictions. The problem that sales factor apportionment creates occurs when companies A and B are unrelated and in different taxing jurisdictions. For companies that produce and sell high-valued final products for which there is value in the marketing of a brand (for example, cellphones, soft drinks, and automobiles), using an unrelated party to complete the sale would be problematic because it would require relinquishing some control over the value chain. For companies that produce and sell high-valued intermediate products, such as computer chips and software, using an unrelated party to complete the sale would entail less risk and may be possible.

Whether the goods and services are tangible or intangible, and whether the tax is an income, sales, or excise tax, a common theme has emerged: That the party with nexus should be the entity that creates the market (including advertising and marketing efforts), causes the sale (by being more than a freight forwarder), and supports, warrants, or is held accountable by regulators for the product or service. In Scripto Inc. v. Carson,38 the Supreme Court determined that even though Scripto Inc. had no physical presence in the state of Florida, it could still be held liable for sales taxes associated with independent agents' sales of its products there. Agency nexus is an important part of sales and excise tax administration. The IRS, in Rev. Rul. 69-393, 1969-2 C.B. 206, said that the party liable for the firearms excise tax when an importer is a part of the sale is "the person who as principal and not as agent arranges for, or is the inducing and efficient cause of, the firearms being brought into the United States for the purposes of sale or use" (emphasis added). The practical effect of this ruling, which permeates all federal manufacturers' excise tax nexus issues to this day, is that to be liable for a manufacturers' excise tax, the party that brings the goods into the United States must have substantial "skin in the game" in terms of risk for the products and have responsibility for creating its market. It will not be straightforward for a multinational corporation to insert an unrelated party into its high-value supply chain in order to shift sales out of the United States. Further, in Geoffrey v. South Carolina State Tax Commission,39 the South Carolina Supreme Court held that a company with no physical presence in the state had nexus for income tax purposes because it licensed trademarks to Toys R Us Inc., which operated within the state.

These cases illustrate an important point about nexus and tax administration. Courts have generally supported a tax authority's efforts to defend its tax base -- whether a sales- or income-determined base -- when conduit sales are part of an arrangement that undermines the amount of liability reported. The overall theme has been that conduits must have substantial risk for the goods they bring to market, and here lies the rub for a multinational business. To use a conduit to undermine the tax base, a multinational must relinquish some control over its supply chain and over the way it brings goods to market. Many multinational businesses would be reluctant to do this, because their supply chain is a significant source of profit. Still, how the lines are drawn in determining nexus for a single-sales-factor apportionment of global profits is unknown at this time. Additional effort will be necessary to refine how nexus will affect the tax base. The static estimates of the tax base in this analysis assume no leakage as a result of tax avoidance.


IV. Conclusion

Single-sales-factor apportionment of corporate global profits has several attractive features that warrant further consideration for corporate tax reform. The current corporate income tax system raises little revenue from foreign-source income and requires a lot of tax administrator and taxpayer effort, time, and expense. The absence of third-party information reporting is the hallmark of an inefficient tax system, and the current corporate income tax system lacks a reinforcing information regime that supports the tax base. Single-sales-factor apportionment of global profits can address these shortcomings by aligning the shareholders' interest in global profits with the tax authority's interest in transparent measurement of the tax base. Apportioning global profits can result in a much larger tax base than the current system of separate accounting. However, the design of a single-sales-factor apportionment system will put pressure on the rules establishing nexus for tax purposes. Much work remains to be done to develop these rules for application to a corporate income tax. But much work has already been done on nexus in other tax systems, and the common themes that have emerged from that work can be usefully applied to single-sales-factor apportionment of global profits.40

           Table 5. Taxable Income, Apportioned Profits, and
                    Sample Counts by Industry, 2010
                            ($ in billions)
 ______________________________________________________________________

 Net income for tax returns

                    Petroleum       Mining          Pharmaceutical
                    Manufacturing   Manufacturing   Manufacturing
                    ___________________________________________________

                        $132              $28            $46

                                    Computer and
                    Chemical        Electronics     Transportation
                    Manufacturing   Manufacturing   Manufacturing
                    ___________________________________________________

                         $39             $69              $18

                                    Retail          Wholesale
                    Insurance       Trade           Trade
                    ___________________________________________________

                        $77            $68               $66

                                    Professional,
                                    Scientific,
                                    and
                                    Technical
                    Information     Services        Construction
                    ___________________________________________________

                         $64               $7             -$4

                    Healthcare      Accommodation
                    and Social      and Food
                    Assistance      Services
                    ___________________________________________________

                          $7               $6
 ______________________________________________________________________

 Apportioned global profits* for financial statements sample

                    Petroleum       Mining          Pharmaceutical
                    Manufacturing   Manufacturing   Manufacturing
                    ___________________________________________________

                        $191              $89            $76

                                    Computer and
                    Chemical        Electronics     Transportation
                    Manufacturing   Manufacturing   Manufacturing
                    ___________________________________________________

                         $59             $75              $62

                                    Retail          Wholesale
                    Insurance       Trade           Trade
                    ___________________________________________________

                       $151           $122               $75

                                    Professional,
                                    Scientific,
                                    and
                                    Technical
                    Information     Services        Construction
                    ___________________________________________________

                        $155              $77              $9

                    Healthcare      Accommodation
                    and Social      and Food
                    Assistance      Services
                    ___________________________________________________

                         $36              $22
 ______________________________________________________________________

 Tax returns, counts

                    Petroleum       Mining          Pharmaceutical
                    Manufacturing   Manufacturing   Manufacturing
                    ___________________________________________________

                         380           13,050            702

                                    Computer and
                    Chemical        Electronics     Transportation
                    Manufacturing   Manufacturing   Manufacturing
                    ___________________________________________________

                       3,555           6,800            3,728

                                    Retail          Wholesale
                    Insurance       Trade           Trade
                    ___________________________________________________

                     36,073        174,683           138,041

                                    Professional,
                                    Scientific,
                                    and
                                    Technical
                    Information     Services        Construction
                    ___________________________________________________

                      45,336          209,282         164,635

                    Healthcare      Accommodation
                    and Social      and Food
                    Assistance      Services
                    ___________________________________________________

                     116,253           75,995
 ______________________________________________________________________

 Financial statements sample, counts

                    Petroleum       Mining          Pharmaceutical
                    Manufacturing   Manufacturing   Manufacturing
                    ___________________________________________________

                         218               47            189

                                    Computer and
                    Chemical        Electronics     Transportation
                    Manufacturing   Manufacturing   Manufacturing
                    ___________________________________________________

                          60             447              107

                                    Retail          Wholesale
                    Insurance       Trade           Trade
                    ___________________________________________________

                         87            168               113

                                    Professional,
                                    Scientific,
                                    and
                                    Technical
                    Information     Services        Construction
                    ___________________________________________________

                         350              152              62

                    Healthcare      Accommodation
                    and Social      and Food
                    Assistance      Services
                    ___________________________________________________

                          62               59
 ______________________________________________________________________

 Percent coverage based on sales

                    Petroleum       Mining          Pharmaceutical
                    Manufacturing   Manufacturing   Manufacturing
                    ___________________________________________________

                         52%              21%            93%

                                    Computer and
                    Chemical        Electronics     Transportation
                    Manufacturing   Manufacturing   Manufacturing
                    ___________________________________________________

                         37%             75%              74%

                                    Retail          Wholesale
                    Insurance       Trade           Trade
                    ___________________________________________________

                        44%            63%               21%

                                    Professional,
                                    Scientific,
                                    and
                                    Technical
                    Information     Services        Construction
                    ___________________________________________________

                         85%              28%             19%

                    Healthcare      Accommodation
                    and Social      and Food
                    Assistance      Services
                    ___________________________________________________

                         31%              39%
 ______________________________________________________________________

 Present-law income tax before credits

                    Petroleum       Mining          Pharmaceutical
                    Manufacturing   Manufacturing   Manufacturing
                    ___________________________________________________

                         $47              $14            $17

                                    Computer and
                    Chemical        Electronics     Transportation
                    Manufacturing   Manufacturing   Manufacturing
                    ___________________________________________________

                         $13             $24               $8

                                    Retail          Wholesale
                    Insurance       Trade           Trade
                    ___________________________________________________

                        $27            $26               $26

                                    Professional,
                                    Scientific,
                                    and
                                    Technical
                    Information     Services        Construction
                    ___________________________________________________

                         $27              $10              $2

                    Healthcare      Accommodation
                    and Social      and Food
                    Assistance      Services
                    ___________________________________________________

                          $3               $5
 ______________________________________________________________________

 Tax liability from apportioned global profits at 35 percent rate

                    Petroleum       Mining          Pharmaceutical
                    Manufacturing   Manufacturing   Manufacturing
                    ___________________________________________________

                         $67              $31            $27

                                    Computer and
                    Chemical        Electronics     Transportation
                    Manufacturing   Manufacturing   Manufacturing
                    ___________________________________________________

                         $21             $26              $22

                                    Retail          Wholesale
                    Insurance       Trade           Trade
                    ___________________________________________________

                        $53            $43               $26

                                    Professional,
                                    Scientific,
                                    and
                                    Technical
                    Information     Services        Construction
                    ___________________________________________________

                         $54              $27              $3

                    Healthcare      Accommodation
                    and Social      and Food
                    Assistance      Services
                    ___________________________________________________

                         $13               $8
 ______________________________________________________________________

 Present-law income tax after credits

                    Petroleum       Mining          Pharmaceutical
                    Manufacturing   Manufacturing   Manufacturing
                    ___________________________________________________

                          $5               $6             $8

                                    Computer and
                    Chemical        Electronics     Transportation
                    Manufacturing   Manufacturing   Manufacturing
                    ___________________________________________________

                          $7             $13               $6

                                    Retail          Wholesale
                    Insurance       Trade           Trade
                    ___________________________________________________

                        $23            $24               $21

                                    Professional,
                                    Scientific,
                                    and
                                    Technical
                    Information     Services        Construction
                    ___________________________________________________

                         $19               $8              $2

                    Healthcare      Accommodation
                    and Social      and Food
                    Assistance      Services
                    ___________________________________________________

                          $3               $2
 ______________________________________________________________________________

                              FOOTNOTE TO TABLE 5

      * Grossed up to reflect SOI industry size based on business
 receipts in 2010.

                           END OF FOOTNOTE TO TABLE 5

 Source: IRS Statistics of Income, "Corporation Source Book," 2010;
 Company Financial Statements, 2010; DEG calculations.

FOOTNOTES

1 The Congressional Budget Office February 2014 tax receipts baseline shows that over fiscal 2015 through 2024, budget period corporate income tax receipts will be even less, at 18 percent of total income taxes. CBO, "The Budget and Economic Outlook: 2014 to 2024" (Feb. 2014).

2 See Kimberly A. Clausing, "The Revenue Effects of Multinational Firm Income Shifting," Tax Notes, Mar. 28, 2011, p. 1580; National Income and Product Accounts (NIPA) Table 7.16, line 2 adjustment for corporate profits, produced by the Bureau of Economic Analysis; and Reuven S. Avi-Yonah et al., "Allocating Business Profits for Tax Purposes: A Proposal to Adopt a Formulary Profit Split," 9 Fla. Tax Rev. 497 (2009).

3 In 2010 the IRS assessed $26.2 billion in additional tax on corporations under audit -- about the same amount as was paid in tax on foreign-source income that year. See IRS, Data Book 2010, Table 9a.

4 See Deloitte Tax LLP comment letter complaining that changes to the APA procedures are too burdensome (Mar. 13, 2014).

5 After only three years, the Schedule UTP filings are declining when they should be increasing. See J. Richard Harvey Jr., "Surprising Statistics on Corporate Disclosures of Uncertain Tax Positions (UTP)," Procedurally Taxing (Feb. 7, 2014), available at http://www.procedurallytaxing.com/surprising-statistics-on-corporate-disclosures-of-uncertain-tax-positions-utp/?goback=.gde_740757_member_5837617205801414657y/media/documents/Fulbright%20US%20Scholars/ClausingCV.pdf.

6 See OECD, "Discussion Draft on Transfer Pricing Documentation and CbC Reporting" (Jan. 30, 2014) (discussing required separate documentation of cross-country and intracountry pricing within a multinational corporation).

7 See Robert S. McIntyre et al., "The Sorry State of Corporate Taxes: What Fortune 500 Firms Pay (or Don't Pay) in the USA and What They Pay Abroad -- 2008 to 2012" (Feb. 2014), available at http://www.ctj.org/corporatetaxdodgers/sorrystateofcorptaxes.pdf.

8 See Clausing, supra note 2.

9 The BEA NIPA Table 7.16, line 2 adjustment for corporate profits is derived from IRS corporate audit information unavailable to the public.

10 Avi-Yonah et al., supra note 2.

11 See Edward D. Kleinbard, "Through a Latte Darkly: Starbucks's Stateless Income Tax Planning," Tax Notes, June 24, 2013, p. 1515; Susan C. Morse, "Revisiting Global Formulary Apportionment," 29 Va. Tax Rev. 593 (2010); and Avi-Yonah et al., supra note 2.

12 See Clausing, supra note 2. See also Joann M. Weiner, "It's Time to Adopt Formulary Apportionment" (Sept. 9, 2009) (analyzing Merck Group's 1999 through 2006 financial statement income and geographic segment reporting of profits).

13 See Avi-Yonah and Clausing, "Reforming Corporate Taxation in a Global Economy: A Proposal to Adopt Formulary Apportionment," The Brookings Institution Policy Brief No. 2007-08 (June 2007).

14 Statistics of Income Tax Stats, "Returns of Active Corporations," Table 6, Tax Year 2010.

15 See IRS, "Tax Gap for Tax Year 2006, Overview," Table 1 (Jan. 6, 2012).

16 See Rosanne Altshuler and Harry Grubert, "Formula Apportionment: Is It Better Than the Current System and Are There Better Alternatives?" 63 Nat'l Tax J. 1145 (2010).

17 See Daniel Shaviro, "The Optimal Relationship Between Taxable Income and Financial Accounting Income: Analysis and a Proposal," 97 Geo. L.J. 423 (2009).

18 Kleinbard, supra note 11.

19 463 U.S. 159 (1983).

20 62 U.S. 4552 (1994).

21 See Ways and Means Committee, "Technical Explanation of the Ways and Means Discussion Draft Provisions to Establish a Participation Exemption System for the Taxation of Foreign Income" (Oct. 26, 2011).

22 See Baucus discussion draft outlining foreign-source income tax reform.

23 See Michael C. Durst, "Analysis of a Formulary System, Part VIII: Suggested Statutory Regulatory Language for Implementing Formulary Apportionment," Tax Mgmt Transfer Pricing Report, May 1, 2014 (providing a model statute for apportioning global profits).

24 See Hollis Hyans et al., "Mandatory Unitary Combined Reporting Regimes" (Feb. 2013) (presentation to the National Multistate Tax Symposium).

25 See Avi-Yonah and Clausing, supra note 13.

26 See Deloitte, "IFRS 10 -- Consolidated Financial Statements," available at http://www.iasplus.com/en/standards/ifrs/ifrs10#link0.

27 See William F. Fox and LeAnn Luna, "Combined Reporting With the Corporate Income Tax: Issues for State Legislatures," Center for Business and Economic Research, University of Tennessee (Nov. 2010).

28 See Hines, "Income Misattribution Under Formula Apportionment," European Economic Review (2010).

29 See Shirley Sicilian, "Multistate Tax Compact Article IV Recommended Amendments," Multistate Tax Commission (May 3, 2012). See also Walter Hellerstein, "Designing the Limits of Formulary Income Attribution Regimes," State Tax Notes, Apr. 7, 2014, p. 45.

30 See Richard Pomp, "Report of the Hearing Officer, Multistate Tax Compact Article IV (UDITPA), Proposed Amendments" (Oct. 25, 2013); and Durst, "Analysis of a Formulary System, Parts I-VIII," Bloomberg BNA (2014). For a recent economic analysis of the U.S. state experience with formulary apportionment, see Clausing, "Lessons for International Tax Reform From the U.S. State Experience Under Formulary Apportionment" (Jan. 2014). For a detailed economic analysis of formulary apportionment of corporate profits for EU nations, see Robert Cline et al., "Study on the Economic and Budgetary Impact of the Introduction of a Common Consolidated Corporate Tax Base in the European Union," EY (2010). For a review of state experiences with moving toward combined reporting, see Cline, "Combined Reporting: Understanding the Revenue and Competitive Effects of Combined Reporting," EY (2008).

31 Fairness in apportionment factors is a central issue with formulary apportionment schemes and is enshrined in the Multistate Tax Compact Art. IV.18. See Pomp, supra note 30 and Cara Griffith, "What Is a Reasonable Alternative Apportionment Method?" State Tax Notes, Feb. 18, 2013, p. 409.

32 See Henry J. Reske, "West Virginia Seeks Study of Revenue Lost to Offshore Tax Havens" (Mar. 11, 2014).

33 See http://www.districteconomics.com/papers/USsalesfactorapportionment.pdf.

34 We focus on these industries for several reasons. First, the fewest number of financial statements (2,121) cover the broadest amount of corporate tax. This is of practical importance because some of the Compustat financial statement data require manual review to extract geographic market segment information. These 14 industries accounted for 60 percent of filed tax returns but 76 percent of business receipts and 64 percent of taxes paid. Second, these industries report the greatest amounts of foreign-source income and foreign tax credits. They are therefore front and center with the shortcomings of the current corporate income tax regarding erosion of the domestic tax base and a low residual federal income tax on foreign-source income.

35 For an example of alternative taxation rather than single-sales-factor apportionment, see Cal. Code Regs. tit. 18, section 25137.

36 See supra notes 12 and 13.

37 See Sicilian, supra note 29.

38 362 U.S. 207 (1960).

39 437 S.E.2d 13 (S.C. 1993).

40 For a much fuller consideration of nexus issues as they pertain to an income tax, see Charles McLure Jr., "Implementing State Corporate Income Taxes in the Digital Age," 53 Nat'l Tax J. 1287 (2000).


END OF FOOTNOTES



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