Apportioning Investment Income

Introduction

The Washington State Department of Revenue has issued new guidance on apportioning receipts from investment income. In that guidance, the Department states that its current understanding is that "investment income should be attributed to the taxpayer's commercial domicile." The Department further states that it is "not aware of any situations in which the earlier cascading steps would apply" because:

• The investment income is not received in exchange for providing a service, so steps (301)(a) through (c) do not apply.
• The investment income is not associated with an identifiable customer, so steps (301)(d) through (f) do not apply.

Those propositions may be true for the Department's example in the new guidance involving anonymous public-market stock sales. But they should not be treated as categorical rules for all investment income. It is not entirely clear from this guidance how flexible the Department will be allowing alternative conclusions. The better approach is to be more flexible and apply the cascading steps receipt by receipt and move to commercial domicile only when the taxpayer is actually unable to attribute the receipt under the earlier steps.

A "Service" Should Not Be a Threshold Requirement

The first problem is the premise that a traditional "service" must exist before apportionment applies. RCW 82.04.460 applies to "apportionable income from engaging in apportionable activities." The term "apportionable activities" includes activities taxed under RCW 82.04.290, which applies to activities not otherwise taxed under another B&O tax classification. The statute therefore does not require a traditional service as a threshold condition for apportionment.

RCW 82.04.462 likewise provides the general apportionment method for "apportionable income." The receipts factor is calculated using gross income of the business from engaging in apportionable activity. Again, the statute does not limit the apportionment framework to receipts from traditional services. It is true that RCW 82.04.462 and WAC 458-20-19402 later refer to where the customer received the "benefit of the service." But in context, that phrase functions as an attribution rule for gross income from apportionable activity. It should not be read to exclude apportionable "other activities" merely because the taxpayer cannot describe the investment receipt as a conventional service fee.

A Service Can Sometimes Be Identified

Even if a service concept were required, some investment transactions can support one. For example, if Company XYZ purchases stock directly from ABC Company in an IPO, private placement, or other issuer transaction, XYZ is providing capital to ABC. That capital supports ABC's business. In that setting, the relevant activity can be characterized as providing investment capital to the issuer.

A secondary-market purchase is more difficult. If XYZ buys ABC stock from another shareholder, the purchase proceeds generally go to the selling shareholder, not ABC. That transaction may not fairly be characterized as capitalizing ABC's business. But that only proves the analysis is fact-specific.

A Customer or Payor Is Often Identifiable

The Department's second proposition is also too broad. The term "customer" is defined broadly for apportionment purposes. It includes a person or entity to whom the taxpayer makes a sale, grants the right to use intangible property, or renders services, or from whom the taxpayer otherwise directly or indirectly receives gross income of the business. RCW 82.04.462(3)(b)(viii); WAC 458-20-19402(106)(e).

Under that definition, the customer or payor may be identifiable in many investment-income situations. Examples may include:

• a dividend or distribution from a known entity;
• income from a private equity investment;
• income from a real estate partnership.

In those situations, the taxpayer may know the entity from which it receives gross income. The taxpayer may also have records showing the entity's domicile, principal office, billing address, payment location, or other commercially reasonable address. Those facts may not always produce a perfect attribution answer, but they are enough to make the Department's "no identifiable customer" statement too broad.

The Public-Market Example Should Be Limited to Its Facts

The Department's example involving public-market stock sales presents a real attribution problem. In a high-volume public-market trading context, the taxpayer generally does not know the buyer. The issuer is not paying the gain. The broker or clearing system may facilitate the transaction, but it may not be the customer for the taxpayer's investment gain. In that setting, the taxpayer may have no commercially reasonable means to identify the customer, the customer's benefit location, the order location, the billing location, the payment location, or the customer's address.

On those facts, attribution to commercial domicile is reasonable. But the conclusion should be tied to the taxpayer's inability to attribute under the cascading steps, not to a general rule that investment income can never involve a service or an identifiable customer. WAC 458-20-19402(301)(g), (306).

Suggested Improvement to the Guidance

The Department could improve the guidance by narrowing the statement. For example:

Many investment receipts, especially gains from anonymous public-market transactions, may not be attributable under the earlier cascading steps because the taxpayer may have no commercially reasonable means to identify a customer, benefit location, order location, billing location, payment location, or customer address. In those cases, receipts are attributed to the taxpayer's commercial domicile. However, where the taxpayer can identify a payor, issuer, borrower, buyer, or other customer from whom the taxpayer directly or indirectly receives gross income, the taxpayer should apply the cascading steps in RCW 82.04.462 and WAC 458-20-19402 based on the facts and records available.

This formulation preserves the Department's conclusion for anonymous public-market trading gains while avoiding an overstatement that may be wrong for other investment income.

Conclusion

The Department's example reaches a reasonable result. If a taxpayer realizes gains from anonymous public-market trading and cannot commercially identify a customer or attribution location, commercial domicile is likely the correct endpoint. But the Department's broader reasoning should be narrowed. Investment income should not automatically bypass the cascading steps. The correct approach is to identify the receipt, identify any customer or payor if commercially reasonable, apply any rule that may apply, and move down the cascade only when the taxpayer is truly unable to attribute the receipt under the earlier steps.