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The Corporate Executive Board Co. v. Virginia Department of Taxation

Supreme Court of Virginia

February 7, 2019





         The 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.


         I. CEB sells most of its services to customers outside of Virginia.

         CEB is 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.

         The 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.

         For the 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.

         Aside 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, Virginia."

         II. Formulary apportionment under Virginia law.

         Like a 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 borders.

         Bradley W. Joondeph, The Meaning of Fair Apportionment and the Prohibition on Extraterritorial State Taxation, 71 Fordham L. Rev. 149, 155 (2002).

         Since 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. 442.[1] 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." Id.[2]

         Virginia's 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 (1997).

         The 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 Commonwealth; or
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.

         Code § 58.1-416.[3] Aside from minor textual adjustments and recodification, Virginia has retained this sales factor for services for nearly 60 years. See 1960 Acts ch. 442.

         Applying 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.

         III. Other States abandon "cost of performance" sourcing.

         UDITPA's, 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.


         Virginia 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).

         A 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 of ...

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