Allocation and Apportionment of Investment Income

The South Carolina Supreme Court recently ruled against Duke Energy Corporation (“Duke”) in Duke’s claim for a $126 million state income tax refund.  The issue came down to whether gross receipts from Duke’s sales of short-term investments should be included in the apportionment fraction used by South Carolina to divide income among South Carolina and other states in which Duke operates.  The South Carolina Supreme Court’s opinion is important because it can pose significant hurdles to businesses with multi-state operations that have planned with investment income to reduce their South Carolina taxes.

Under South Carolina law, businesses operating in multiple states must apportion their federal taxable income among these various states.  For example, If a business has operations in South Carolina that are 25% of its total operations, South Carolina should only tax 25% of the income of the business.  To accomplish this, South Carolina uses different factors, known as “apportionment factors” which are applied against federal taxable income.  These factors can include assets, employees, and sales.  The primary factor at issue in the Duke Energy case was the “sales” factor.

South Carolina law defines “sales factor” as a fraction where the numerator is the total sales of the taxpayer in the state during the tax year and the denominator is the total sales of the taxpayer everywhere during the tax year (including South Carolina).  No mention is made in the law of “gross receipts” in defining  “sales factor”.  This issue was the focus of the South Carolina Supreme Court’s decision in the Duke Energy case.

Duke is a large, regional utility, providing electric, gas, and other services to its customers.  Duke would invest excess operating cash in short-term marketable securities, and would then sell these securities and reinvest the proceeds.

Duke argued the gains it received from its short-term investments should be considered a “receipt” so that this gain/income should be included in the denominator of its apportionment formula (i.e. sales factor).  If Duke’s argument was adopted, this would allow Duke to increase its total income in the apportionment factor (the denominator), while keeping the South Carolina-based income the same.   Duke’s South Carolina taxes would have been reduced as a result.

The Court disagreed with Duke and stated the focus should be on “sales” and not the broader term “receipts”.  The Court ruled that a recovery of principal from the sale of short-term securities is not a “sale” under the law, and that Duke’s arguments would lead to “absurd results by distorting the sales factor . . . and by defeating the legislative intent of the apportionment statutes.”

The Duke Energy case now stands for the proposition that a return of principal from investment sales is not included in the sales factor for South Carolina income apportionment purposes.

The South Carolina Supreme Court’s decision in this case is particularly important for multi-state businesses.  Should a corporation be able to apportion income away from South Carolina using internal investment gain or income, to a state with a little or no corporate income tax (and there are many of these states), the business could significantly reduce its overall state income tax liability.    This tax-reduction strategy will not work in South Carolina.

Jump to Page
Arrow icon Top

Contact Us

We use cookies to improve your website experience, provide additional security, and remember you when you return to the website. This website does not respond to "Do Not Track" signals. By clicking "Accept," you agree to our use of cookies. To learn more about how we use cookies, please see our Privacy Policy.

Necessary Cookies

Necessary cookies enable core functionality such as security, network management, and accessibility. These cookies may only be disabled by changing your browser settings, but this may affect how the website functions.

Analytical Cookies

Analytical cookies help us improve our website by collecting and reporting information on its usage. We access and process information from these cookies at an aggregate level.