CCH Tax Day Report
The Massachusetts Supreme Judicial Court has affirmed a decision by the Appellate Tax Board (ATB) that a California-based biotech company was required to determine its corporate excise tax liability from the sales of its drugs in Massachusetts using the single sales factor apportionment for manufacturers, rather than the standard three-factor apportionment formula based on property, payroll, and sales, because it was substantially engaged in manufacturing activities in the state. The taxpayer developed the drugs by a process of extracting and purifying proteins produced from the genetic modification of living cells. However, the court agreed with the ATB that this extraction process was not comparable to the extraction of rocks from mining activities, as the taxpayer claimed, because each genetically modified and replicated cell that served as the source of the taxpayer’s drugs was different from the original cell in a fundamental way. Given the clear transformation of the original cell, the court reasoned, the taxpayer’s activities qualified as manufacturing activity within the meaning of the manufacturing apportionment statute. The taxpayer’s activities were also a substantial enough portion of its business to qualify it as a “manufacturing corporation” because 25% or more of its Massachusetts gross receipts were from the sale of manufactured goods. The taxpayer argued that it did not satisfy the 25% gross receipts threshold if receipts from the redemption of securities and return of capital on the financial side of its operations were included in the threshold determination. The court agreed with the ATB that this interpretation of “gross receipts” would dramatically lower the taxpayer’s percentage of receipts from the sale of manufactured goods in Massachusetts and lead to absurd or distortive results, “transforming a biotechnology company with substantial revenue from sales of its specialty drugs into essentially an investment business”. Finally, the court rejected the claim that application of the single-factor apportionment formula to the taxpayer while denying it the benefit of the Massachusetts investment tax credit (ITC) and research and development (R&D) credit for activities in another state violated the dormant Commerce Clause of the U.S. Constitution. According to the legislative history, the single-factor apportionment formula for manufacturers was designed to encourage manufacturers to increase the level of their investment in manufacturing operations in Massachusetts by removing a tax disincentive created by the three-factor formula. This type of business investment encouragement has been recognized by the U.S. Supreme Court as a constitutionally appropriate goal. The court acknowledged that the change in the apportionment formula from one that includes Massachusetts property and payroll to one focusing solely on Massachusetts sales may well have caused the amount of income apportioned to Massachusetts to decrease for manufacturing corporations that conducted their manufacturing operations in the state, and have had the opposite effect on corporations, like the taxpayer, with their manufacturing facilities elsewhere. But the dormant commerce clause does not forbid a state from changing the apportionment formula it uses. The commerce clause forbids a state tax measure that taxes a transaction or incident more heavily when it crosses state lines than when it occurs entirely in the state. The court concluded, therefore, that the single sales factor apportionment formula for manufacturing corporations does not discriminate against interstate commerce on its face or as it was applied to the taxpayer. The unavailability of the ITC or the R&D credit to reduce the taxpayer’s corporate excise tax burden also did not change this result. Those credits were in existence long before the apportionment formula was changed for manufacturers, the credits are available to any in or out-of-state manufacturing corporation for investments of resources in Massachusetts, and the credits operate independently of a corporation’s interstate sales or other interstate commercial activities.
Genentech, Inc. v. Massachusetts Commissioner of Revenue, Massachusetts Supreme Judicial Court, No. SJC-12083, January 12, 2017, ¶401-608