THE CIRCUIT COURT OF ARLINGTON COUNTY Daniel S. Fiore, II,
STEPHEN R. McCULLOUGH, JUSTICE
Corporate Executive Board Company ("CEB")
challenges its income tax assessment for the years 2011,
2012, and 2013. CEB contends that the method employed by the
Virginia Department of Taxation is unconstitutional as
applied to CEB under the "dormant" Commerce Clause
and the Due Process Clause of the United States Constitution.
Alternatively, CEB argues that it is entitled to an
adjustment because the statutory method for computing its tax
constitutes an "inequitable" method under the Tax
Department's regulations. For the reasons noted below, we
will affirm the judgment of the circuit court.
sells most of its services to customers outside of Virginia.
a corporation that is headquartered in Arlington, Virginia.
CEB describes itself as "the premier 'best
practices' advisory firm in the world." Most of
CEB's revenue comes from an annual fixed fee subscription
service of its "Core Product." This subscription
service provides "online access to best practices
research, executive education and networking events, and
tools used by executives to analyze business functions and
processes." In addition, CEB sells professional
services, or "Solutions," that include employee
education and performance analytics. It also conducts
executive education seminars. CEB's customers include 97%
of the Fortune 100 companies and more than 10, 000 additional
organizations in more than 50 countries.
vast majority of CEB's sales of its Core Product and
Solutions, over 95%, occur outside of Virginia. The
Commonwealth accounts for less than 5% of CEB's gross
revenue. For the three years at issue, CEB earned $1.76
billion in total sales. Of that total, Virginia accounted for
about $66 million.
tax years in question,
[T]he majority (more than 50%) of CEB's employees who
developed and improved the content integrated into the online
components of CEB's products, and the costs of
performance associated with developing and improving that
content, were located in Arlington, Virginia.
from "live learning events, executive networking, and
customized advisory support," the entirety of the
content "developed and integrated into the online
components of the Core Product was housed on CEB's
servers located in Arlington, Virginia." These
"servers were managed and/or controlled by CEB's
Information Technology function located in Arlington,
Formulary apportionment under Virginia law.
majority of States, Virginia imposes a corporate income tax.
Code § 58.1-400 et seq. Virginia
employs a formula to determine which portion of a
corporation's income it can properly tax.
Because tracing income earned by an interstate business to
its geographic origin based on some type of separate
accounting methodology presents enormous practical problems
(and is arguably incoherent in theory), states have long used
the method of formulary apportionment to determine the amount
of income earned by multistate corporations within their
W. Joondeph, The Meaning of Fair Apportionment and the
Prohibition on Extraterritorial State Taxation,
71 Fordham L. Rev. 149, 155 (2002).
1960, Virginia has adhered to the approach recommended by the
National Conference of Commissioners on Uniform State Laws in
1957 in a model statute. See 1960 Acts ch.
This model statute is the Uniform Division of Income for Tax
Purposes Act, or UDITPA. UDITPA was drafted to address the
fact that States had adopted "various formulae for
determining the amount of income to be taxed, and the
differences in the formulae produce inequitable
results." Uniform Division of Income for Tax Purposes
Act, Prefatory Note, 3 (1957). UDITPA sought to provide
"a uniform method of division of income for tax purposes
among the several taxing jurisdictions."
UDITPA-based statute employs a three-factor formula to
determine the taxable income of a corporation. Code §
58.1-408. Many States employ a similar approach. See
Steven Maguire, Congressional Research Service, State
Corporate Income Taxes: A Description and Analysis at 4
(2006) (hereafter "State Corporate Income Taxes")
("Typically, three factors of economic activity are used
in the apportionment formula to measure the economic presence
of a firm in a state: the percentage of property, the
percentage of sales, and the percentage of payroll.").
In Virginia, the numerator of the fraction consists of three
factors: a payroll factor, a property factor, and a
double-weighted sales factor. Code § 58.1-408. The
denominator is four. Id. "In practice, there is
relatively little controversy surrounding the [property and
payroll factors]." Walter Hellerstein, State
Taxation of Electronic Commerce, 52 Tax L. Rev. 425, 476
sales factor is based on the ratio of a corporation's
"sales . . . in the Commonwealth" to its total
"sales . . . everywhere." Code § 58.1-414. The
sales factor varies depending on whether the property is
tangible or intangible. For tangible personal
property, Virginia's sales factor attributes the income
from the sale to the source of the revenue, i.e.
where the customer is located. Code § 58.1-415. This
approach, modeled on UDITPA § 16, is known as
destination-based, or market-based, sourcing. Virginia
modeled the sales factor for sales of intangible
personal property, including services like CEB's Core
Product, on UDITPA § 17. Virginia includes sales of
intangible property as part of income if:
1. The income-producing activity is performed in the
2. The income-producing activity is performed both in and
outside the Commonwealth and a greater portion of the
income-producing activity is performed in the Commonwealth
than in any other state, based on costs of performance.
§ 58.1-416. Aside from minor textual adjustments and
recodification, Virginia has retained this sales factor for
services for nearly 60 years. See 1960 Acts ch. 442.
this long-accepted "costs of performance" formula
for sales of services means that the Tax Department allocated
nearly 100% of CEB's gross receipts to Virginia. This
allocation occurred because the service CEB provides was
developed in Virginia by CEB's Virginia employees, and
its product is stored on servers located in Virginia.
Other States abandon "cost of performance"
and, therefore, Virginia's, "costs of
performance" sales factor has faced mounting criticism.
See, e.g., John A. Swain, Reforming the State
Corporate Income Tax: A Market State Approach to the
Sourcing of Service Receipts, 83 Tul. L. Rev. 285, 289
(2008). UDITPA was adopted in 1957. It "was written
against the backdrop of an economy dominated by mercantile
and manufacturing enterprises." Id. at 287.
The U.S. economy, however, has changed dramatically since
that time. Production has shifted steadily from goods to
services and intangibles, and the forces of globalization,
spurred by the revolution in communications technology, now
allow many more goods and services to be supplied remotely.
This puts tremendous pressure on division of income rules
that were developed in another era.
has repeatedly studied whether to alter its apportionment
formula for services, but, to date, the General Assembly has
not changed it. See John P. Josephs, Jr.,
Virginia's Apportionment Formula, Presented to
the Joint Subcommittee Studying the Benefits of Adopting a
Single Sales Factor (September 30, 2008); Joint Legislative
Audit and Review Commission, Report to the Governor and the
General Assembly of Virginia, Review of Virginia's
Corporate Income Tax System (November 2010). Several
bills have been introduced to that effect, but they have not
passed. See H.B. 1604, Va. Gen. Assem. (Reg. Sess.
2011), S.B. 1006, Va. Gen. Assem. (Reg. Sess. 2011), H.B.
2253, Va. Gen. Assem. (Reg. Sess. 2013), H.B. 442, Va. Gen.
Assem. (Reg. Sess. 2014).
growing number of States have revisited their method of
apportioning income from the sale of services. "The
cost-of-performance method is waning, and market sourcing is
taking its place." Douglas A. Wick, A Categorization