Allocation and Apportionment: Lessons From the United States

By: Labry Welty
BNA Tax Planning International Review, Vol 32, No. 6
June 2005

In this article we look at allocation and apportionment based on the U.S. state tax system.  First, we summarise the limits on the States' powers to tax, the UDITPA and the Multistate Tax Commission. We then consider the right to divide the state income tax base, business vs. non-business income distinction and formulary apportionment. Finally, we look at what may be learned from the U.S. state tax apportionment system.

I. Introduction
A. Limits on the States' Powers to Tax: NexusIn the United States, a state's ability to impose income tax on a foreign business entity engaged in interstate or international commerce is limited by the Commerce and Due Process Clauses of the U.S. Constitution, and controlled by U.S. Supreme Court interpretations of these Clauses, as well as by Federal statute. Generally, a state has jurisdiction to impose an income tax (or franchise tax based on income) if the activity of a business entity is sufficient to establish nexus with the taxing jurisdiction. State statutes impute jurisdiction based on factors such as doing business or owning property within the state. Since nexus is separately defined and interpreted by each state's courts the level of contact necessary to create nexus varies among the states even when state jurisdiction statutes are similar.

When more than one state has jurisdiction to impose income tax on a business, a method of fair apportionment of income between the states is needed to mitigate the problem of double taxation.

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