News and Insights

Cost of Performance Stands as the Virginia Method of Apportionment

Tax Development Feb 12, 2019

As a follow-up to our release on September 15, 2017,1 the Virginia Supreme Court affirmed the Circuit Court’s decision in Corporate Executive Board (“CEB”) v. Virginia Department of Taxation.2 In a well-written opinion, Virginia Supreme Court Justice Stephen R. McCullough did an excellent job of analyzing the U.S. Supreme Court precedents and the Virginia statutes. 

The case involved the apportionment formula to be used in the sourcing of business advisory services and a database. The services, analysis to populate the database, and the servers were located in Virginia. It was argued that the taxpayer’s income was taxed twice. First, by Virginia under its cost-of-performance analysis, and secondly, by the market states that impose a tax based on the market for the services. 

The Court upheld the apportionment formula used by Virginia, noting that it is not Virginia law that has created the double tax situation but the changes in the apportionment formulas of other states. As noted in the opinion, many states have gone to a single-factor, market-based apportionment system to attract businesses to locate to their respective states, and CEB is being hurt by not locating in a market state. 

One of the more important U.S. Supreme Court decisions, which was prominent in the Virginia court’s analysis, was Moorman Manufacturing.3 Unfortunately, since 1978, Moorman has stood for the principle that a single-factor formula is constitutional. However, the Moorman decision seems to be very factually specific to the facts of the case. Now with almost a 50-50 split among the states between single-factor market-based formulas and three-factor cost-of-performance formulas, perhaps it is time to revisit Moorman.

In many cases, one could argue that the single-factor market state rules act as an incentive, discriminating against out-of-state taxpayers. The single-factor market state formulas also would appear to violate the fourth prong of Complete Auto: “fairly related to services or benefits provided by the state,”4 as the only benefit provided by the market state is the organized society into which the seller directs its services. Although this test was touched on by the recent Wayfair decision, it may be a ripe avenue to challenge a single-factor market-based formula. 

One of the other interesting aspects of this opinion was the Court’s conclusion that the market-sourcing of receipts is not a “unique” method of apportionment. While many states have shifted to a market-based formula, the specific formulas used vary significantly. Noting that both Wisconsin and California employ a “benefits received” approach, the results in each differ greatly. California provides rules that if the location in which the benefit is received is difficult to determine, the state sources the income to the place where the customer ordered the services, or, as a last choice, the customer’s billing address. Wisconsin does not provide for a default to an order or billing address, when the location of the benefits received cannot be determined.  

The Virginia court also contrasts the statutes in two other market-based sourcing states, Alabama and Illinois. While both states use a “services delivered” approach to market-based sourcing, again, the specific application of the rules in these states results in different apportionment. In Alabama, if the service has a substantial connection to a specific geographic location in Alabama, the sale is sourced to the state. If there is no connection to a specific geographic location, the sale is sourced to Alabama if the business is commercially domiciled in Alabama. Conversely, in Illinois, if the place to which a service is delivered is not readily determinable, the sale is sourced to Illinois if the customer’s ordering office or billing address is in Illinois. Again, based on the diversities of states’ market-based sourcing statutes and regulations, perhaps it is time for a court to determine the suitibility of such diversity. 

2 The Corp. Exec. Bd. Co. v. Va. Dep’t of Taxation, Va., No. 171627 (February 7, 2019).
3 Moorman Mfg. Co. v. Bair, 437 U.S. 267 (1978).
4 Complete Auto Transit, Inc., v. Brady, 430 U.S. 274 (1977).


Mark Nachbar

Mary Bernard