The Corporate Executive Board Company (CEB) is headquartered in Arlington, Virginia and provides research and advisory services to large businesses around the world. During the 2011 – 2013 tax years, CEB derived over 95 percent of its revenue from sales to customers outside of Virginia. Based on Virginia’s statutory method of apportionment, in addition to reporting the majority of property and payroll in the Commonwealth, CEB assigned 100 percent of its sales to Virginia under Virginia’s “costs of performance” sourcing rule, which deemed all of CEB’s sales to be Virginia sales. CEB also paid tax in dozens of other jurisdictions and assigned a large percentage of its sales to those states, as well.
CEB filed a refund claim requesting to use an alternative method of apportionment that would substitute a market-based rule for sourcing its receipts from sales of services for the statutory costs of performance sourcing rule. The Department of Taxation denied CEB’s administrative claim. The Arlington Circuit Court granted summary judgment in favor of the Department on September 1, 2017. CEB appealed to the Supreme Court of Virginia.
Under Virginia’s alternative apportionment regime, the Department will grant permission to use an alternative method of apportionment in two circumstances. First, if the statutory method produces an unconstitutional result under the particular taxpayer’s facts and circumstances (i.e., if the statutory method is inapplicable). Second, if the statutory method results in double taxation of the taxpayer’s income, and the inequity is attributable to Virginia rather than to the fact that some other state has a unique method of allocation and apportionment (i.e., if the statutory method is inequitable).2
CEB argued that Virginia’s statutory sourcing rule produced an unfair apportionment under the dormant Commerce Clause because it ignored the existence of interstate commerce, resulted in a significantly higher share of income being apportioned to Virginia than Virginia was entitled to tax, and produced substantial double taxation. However, the Court ruled that the statutory method was externally consistent because it captured, in a reasonable sense, how CEB’s income was generated. The Court pointed to the fact that CEB employees working in Virginia developed the content for CEB’s products and that the servers on which the products resided were located in Virginia.
With regard to inequity, the Court agreed that CEB satisfied the first prong of the Department’s regulation, that the statutory method resulted in double taxation. In fact, the parties stipulated that CEB has paid tax on a multistate basis on an apportioned amount of income that well exceeded 120 percent of CEB’s nationwide income. However, the Court found that the double taxation was not attributable to the Commonwealth because Virginia has applied the same costs of performance sourcing rule for decades. Instead, the Court held that it was other states’ adoption of market-based sourcing over the years that caused the double taxation. The Court was unable to say whether any of the other states to which CEB assigned sales applied a “unique” method of apportionment. Accordingly, CEB did not meet its burden of showing that the statutory method produced an inequitable result.
Reed Smith takeaway
This case continues the trend of taxpayers being unsuccessful in obtaining alternative apportionment relief, despite the fact that in several recent cases courts have allowed state revenue departments to force taxpayers to use alternative apportionment methods. This case is especially interesting because the Court actually found double taxation in the record. Nevertheless, it is not surprising that the Virginia Supreme Court ruled against CEB on the constitutional argument – an extremely high burden to meet. On the other hand, the Court’s “unique” analysis of the statutory inequity prong is curious. Based on the Court’s interpretation of the pertinent regulation, it appears that it would be difficult for any taxpayer to demonstrate that any particular instance of double taxation is attributable to Virginia.
- The case is The Corporate Executive Board Co. v. Virginia Department of Taxation, record number 171627, in the Supreme Court of Virginia (February 7, 2019). For a copy of the decision, please contact one of the authors of this alert.
- See Va. Code § 58.1-421; see also 23 VAC § 10-120-280(B)(4)(b).
Client Alert 2019-037