Colo. Code Regs. 39-22-303.6-2

Current through Register Vol. 47, No. 19, October 10, 2024

Rule 39-22-303.6-2 - Apportionable and Nonapportionable Income

Basis and Purpose. The bases of this rule are §§ 39-21-112, 39-22-301, and 39-22-303.6, C.R.S. The purpose of this rule is to provide guidance for determining what is apportionable and nonapportionable income. Consistent with the General Assembly's adoption of § 39-22-303.6, C.R.S., these rules are intended to conform the state's income tax laws to the Multistate Tax Commission's model statute and regulation except when those model provisions are inconsistent with Colorado statute. See 2018 Colo. Sess. Laws, ch. 369, § 1(2).

(1)General Rule. Section 39-22-303.6(1)(a) and (c), C.R.S., requires every item of income be classified either as apportionable income or nonapportionable income. Income for purposes of classification as apportionable or nonapportionable includes gains and losses. Apportionable income is apportioned among jurisdictions by use of a formula. Nonapportionable income is specifically assigned or allocated to one or more specific jurisdictions pursuant to express rules. An item of income is classified as apportionable income if it falls within the definition of apportionable income. An item of income is nonapportionable income only if it does not meet the definitional requirements for being classified as apportionable income.

(2)Apportionable Income.

(a) Apportionable income means:

(i) any income that would be allocable to Colorado under the United States Constitution, but that is apportioned rather than allocated pursuant to the laws of this state.

(ii) all income that is apportionable under the United States Constitution and is not allocated under the laws of this state, including:

(A) income arising from transactions and activity in the regular course of the taxpayer's trade or business; and

(B) income arising from tangible and intangible property if the acquisition, management, employment, development, or disposition of the property is or was related to the operation of the taxpayer's trade or business.

(b) The classification of income by the labels occasionally used, such as manufacturing income, compensation for services, sales income, interest, dividends, rents, royalties, gains, income derived from accounts receivable, operating income, non-operating income, etc., is of no aid in determining whether income is apportionable or nonapportionable income.

(3)Principal Tests of Apportionable Income.

(a)Transactional Test. Apportionable income includes income arising from transactions and activity in the regular course of the taxpayer's trade or business.

(i) If the transaction or activity is in the regular course of the taxpayer's trade or business, part of which trade or business is conducted within Colorado, the resulting income of the transaction or activity is apportionable income for Colorado. Income may be apportionable income even though the actual transaction or activity that gives rise to the income does not occur in Colorado.

(ii) For a transaction or activity to be in the regular course of the taxpayer's trade or business, the transaction or activity need not be one that frequently occurs in the trade or business. Most, but not all, frequently occurring transactions or activities will be in the regular course of that trade or business and will, therefore, satisfy the transactional test. It is sufficient to classify a transaction or activity as being in the regular course of a trade or business, if it is reasonable to conclude transactions of that type are customary in the kind of trade or business being conducted or are within the scope of what that kind of trade or business does. However, even if a taxpayer frequently or customarily engages in investment activities, if those activities are for the taxpayer's mere financial betterment rather than for the operations of the trade or business, such activities do not satisfy the transactional test.

(iii) The transactional test includes, but is not limited to, income from sales of:

(A) inventory;

(B) property held for sale to customers;

(C) services which are commonly sold by the trade or business; and

(D) property used in the production of apportionable income of a kind that is sold and replaced with some regularity, even if replaced less frequently than once a year.

(b)Functional Test. Apportionable income also includes income arising from tangible and intangible property if the acquisition, management, employment, development, or disposition of the property is or was related to the operation of the taxpayer's trade or business.

(i) "Property" includes any direct or indirect interest in, control over, or use of real property, tangible personal property, and intangible property by the taxpayer.

(ii) Property that is "related to the operation of the trade or business" refers to property that is or was used to contribute to the production of apportionable income directly or indirectly, without regard to the materiality of the contribution. Property that is held merely for investment purposes is not related to the operation of the trade or business.

(iii) "Acquisition, management, employment, development or disposition" refers to a taxpayer's activities in acquiring property, exercising control and dominion over property, and disposing of property, including dispositions by sale, lease, or license. Income arising from the disposition or other utilization of property that was acquired or developed in the course of the taxpayer's trade or business constitutes apportionable income, even if the property was not directly employed in the operation of the taxpayer's trade or business.

(iv)Application of Functional Test.

(A) Income from the disposition or other utilization of property is apportionable if the property is or was related to the operation of the taxpayer's trade or business. This is true even though the transaction or activity from which the income is derived did not occur in the regular course of the taxpayer's trade or business.

(B) Income that is derived from isolated sales, leases, assignments, licenses, and other infrequently occurring dispositions, transfers, or transactions involving property, including transactions made in the full or partial liquidation or the winding-up of any portion of the trade or business, is apportionable income if the property is or was related to the taxpayer's trade or business. Income from the licensing of an intangible asset, such as a patent, copyright, trademark, service mark, know-how, trade secrets, or the like that was developed or acquired for use by the taxpayer in its trade or business constitutes apportionable income whether or not the licensing itself constituted the operation of a trade or business, and whether or not the taxpayer remains in the same trade or business from or for which the intangible asset was developed or acquired.

(C) Income from intangible property is apportionable income when the intangible property serves an operational function as opposed to solely an investment function.

(D) If the acquisition, management, employment, development, or disposition of the property is or was related to the operation of the taxpayer's trade or business, then income from that property is apportionable income even if the actual transaction or activity involving the property that gives rise to the income does not occur in Colorado.

(E) Income from the disposition or other utilization of property that has been withdrawn from use in the taxpayer's trade or business and is instead held solely for unrelated investment purposes is not apportionable. Property that was related to the operation of the taxpayer's trade or business is not considered converted to investment purposes merely because it is placed for sale, but any property which has been withdrawn from use in the taxpayer's trade or business for five years or more is presumed to be held for investment purposes.

(F) If, with respect to an item of property, a taxpayer takes a deduction from income that is apportioned to Colorado, it is presumed that the item of property is or was related to the operation of the taxpayer's trade or business. No presumption arises from the absence of any of these actions.

(G) Application of the functional test is generally unaffected by the form of the property (e.g., tangible, intangible, real, or personal property). Income arising from an intangible interest, as, for example, corporate stock or other intangible interest in an entity or a group of assets, is apportionable income when the intangible itself, or the property underlying or associated with the intangible, is or was related to the operation of the taxpayer's trade or business. Thus, while apportionment of income derived from transactions involving intangible property may be supported by a finding that the issuer of the intangible property and the taxpayer are engaged in the same trade or business, i.e., the same unitary business, establishment of such a relationship is not the exclusive basis for concluding that the income is subject to apportionment. It is sufficient to support the finding of apportionable income if the holding of the intangible interest served an operational rather than an investment function.

(v)Examples.

(A)Example (i): Taxpayer purchases a chain of 100 retail stores for the purpose of merging those store operations with its existing business. Five of the retail stores are redundant under the taxpayer's business plan and are sold six months after acquisition. Even though the five stores were never integrated into the taxpayer's trade or business, the income is apportionable because the property's acquisition was related to the taxpayer's trade or business.

(B)Example (ii): Taxpayer is in the business of developing adhesives for industrial and construction uses. In the course of its business, it accidentally creates a weak but non-toxic adhesive and patents the formula, awaiting future applications. Another manufacturer uses the formula to create temporary body tattoos. Taxpayer wins a patent infringement suit against the other manufacturer. The entire damages award, including interest and punitive damages, constitutes apportionable income.

(C)Example (iii): Taxpayer is engaged in the oil refining business and maintains a cash reserve for buying and selling oil on the spot market as conditions warrant. The reserve is held in overnight "repurchase agreement" accounts of U.S. treasuries with a local bank. The interest on those amounts is apportionable income because the reserves are necessary for the taxpayer's business operations. Over time, the cash in the reserve account grows to the point that it exceeds any reasonably expected requirement for acquisition of oil or other short-term capital needs and is held pending subsequent business investment opportunities. The interest received on the excess amount is nonapportionable income.

(D)Example (iv): A manufacturer decides to sell one of its redundant factories to a real estate developer and transfers the ownership of the factory to a special purpose subsidiary, SaleCo, immediately prior to its sale to the real estate developer. The parties elect to treat the sale as a disposition of assets under section 338(h)(10) of the Code, resulting in SaleCo recognizing a capital gain on the sale. The capital gain is apportionable income. Note: although the gain is apportionable, application of the standard apportionment formula in § 39-22-303.6(6), C.R.S., may not fairly reflect the taxpayer's business presence in any state, necessitating resort to equitable apportionment pursuant to § 39-22-303.6(9), C.R.S.

(E)Example (v): A manufacturer purchases raw materials to be incorporated into the product it offers for sale. The nature of the raw materials is such that the purchase price is subject to extreme price volatility. In order to protect itself from extreme price increases (or decreases), the manufacturer enters into futures contracts pursuant to which the manufacturer can either purchase a set amount of the raw materials for a fixed price, within a specified time period, or resell the futures contract. Any gain on the sale of the futures contract would be considered apportionable income, regardless of whether the contracts were made or resold in Colorado.

(F)Example (vi): A national retailer produces substantial revenue related to the operation of its trade or business. It invests a large portion of the revenue in fixed income securities that are divided into three categories:

(a) short-term securities held pending use of the funds in the taxpayer's trade or business;

(b) short-term securities held pending acquisition of other companies or favorable developments in the long-term money market; and

(c) long-term securities held as an investment. Interest income on the short-term securities held pending use of the funds in the taxpayer's trade or business (a) is apportionable income because the funds represent working capital necessary to the operations of the taxpayer's trade or business. Interest income derived from the other investment securities ((b) and (c)) is not apportionable income as those securities were not held in furtherance of the taxpayer's trade or business.

(4)Nonapportionable Income. Nonapportionable income means all income other than apportionable income.

(5)General Rules for Certain Classes of Income. The following applies the foregoing principles for purposes of determining whether particular income is apportionable or nonapportionable income.

The examples used throughout these rules are illustrative only and are limited to the facts they contain.

(a)Rents from Real and Tangible Personal Property. Rental income from real and tangible property is apportionable income if the property with respect to which the rental income was received is or was used in the taxpayer's trade or business.

(i)Example (i): The taxpayer operates a multistate car rental business. The income from car rentals is apportionable income.

(ii)Example (ii): The taxpayer is engaged in the heavy construction business in which it uses equipment such as cranes, tractors, and earth-moving vehicles. The taxpayer makes short-term leases of the equipment when particular pieces of equipment are not needed on any particular project. The rental income is apportionable income.

(iii)Example (iii): The taxpayer operates a multistate chain of men's clothing stores. The taxpayer purchases a five-story office building for use in connection with its trade or business. It uses the street floor as one of its retail stores and the second and third floors for its general corporate headquarters. The remaining two floors are held for future use in the trade or business and are leased to tenants on a short-term basis in the meantime. The rental income is apportionable income.

(iv)Example (iv): The taxpayer operates a multistate chain of grocery stores. It purchases as an investment an office building in another state with surplus funds and leases the entire building to others. The net rental income is not apportionable income of the grocery store trade or business. Therefore, the net rental income is nonapportionable income.

(v)Example (v): The taxpayer operates a multistate chain of men's clothing stores. The taxpayer invests in a 20-story office building and uses the street floor as one of its retail stores and the second floor for its general corporate headquarters. The remaining 18 floors are leased to others. The rental of the 18 floors is not done in furtherance of but rather is separate from the operation of the taxpayer's trade or business. The net rental income is not apportionable income of the clothing store trade or business. Therefore, the net rental income is nonapportionable income.

(vi)Example (vi): The taxpayer constructed a plant for use in its multistate manufacturing business, and 20 years later the plant was closed and put up for sale. The plant was rented for a temporary period from the time it was closed by the taxpayer until it was sold 18 months later. The rental income is apportionable income and the gain on the sale of the plant is apportionable income.

(b)Gains or Losses from Sales of Assets. Gain or loss from the sale, exchange, or other disposition of real property or of tangible or intangible personal property constitutes apportionable income if the property, while owned by the taxpayer, was related to the operation of the taxpayer's trade or business.

(i)Example (i): In conducting its multistate manufacturing business, the taxpayer systematically replaces automobiles, machines, and other equipment used in the trade or business. The gains or losses resulting from those sales constitute apportionable income.

(ii)Example (ii): The taxpayer constructed a plant for use in its multistate manufacturing business and 20 years later sold the property at a gain while it was in operation by the taxpayer. The gain is apportionable income.

(iii)Example (iii): Same as (ii) except that the plant was closed and put up for sale but was not in fact sold until a buyer was found 18 months later. The gain is apportionable income.

(iv)Example (iv): Same as (ii) except that the plant was rented while being held for sale. The rental income is apportionable income and the gain on the sale of the plant is apportionable income.

(c)Interest. Interest income is apportionable income when the intangible with respect to which the interest was received arose out of, or was created in, the regular course of the taxpayer's trade or business, or the purpose of acquiring and holding the intangible is or was related to the operation of the taxpayer's trade or business.

(i)Example (i): The taxpayer operates a multistate chain of department stores,selling for cash and on credit. Service charges, interest, or time-price differentials and the like are received with respect to installment sales and revolving charge accounts.These amounts are apportionable income.

(ii)Example (ii): The taxpayer conducts a multistate manufacturing business. During the year, the taxpayer receives a federal income tax refund pertaining to the taxpayer's trade or business and collects a judgment against a debtor of the business. Both the tax refund and the judgment bear interest. The interest income is apportionable income.

(iii)Example (iii): The taxpayer is engaged in a multistate manufacturing and wholesaling business. In connection with that business, the taxpayer maintains special accounts to cover such items as workmen's compensation claims, rain and storm damage, machinery replacement, etc. The funds in those accounts earn interest. Similarly, the taxpayer temporarily invests funds intended for payment of federal, state, and local tax obligations pertaining to the taxpayer's trade or business. The interest income is apportionable income.

(iv)Example (iv): The taxpayer is engaged in a multistate money order and traveler's check business. In addition to the fees received in connection with the sale of the money orders and traveler's checks, the taxpayer earns interest income by the investment of the funds pending their redemption. The interest income is apportionable income.

(v)Example (v): The taxpayer is engaged in a multistate manufacturing and selling business. The taxpayer usually has working capital and extra cash totaling $200,000 that it regularly invests in short-term interest bearing securities. The interest income is apportionable income.

(vi)Example (vi): In January, the taxpayer sold all of the stock of a subsidiary for $20,000,000. The funds are placed in an interest-bearing account pending a decision by management as to how the funds are to be utilized. The funds are not pledged for use in the business. The interest income for the entire period between the receipt of the funds and their subsequent utilization or distribution to shareholders is nonapportionable income.

(d)Dividends. Dividends are apportionable income when the stock with respect to which the dividends were received arose out of or was acquired in the regular course of the taxpayer's trade or business, or when the purpose for acquiring and holding the stock is or was related to the operation of the taxpayer's trade or business, or contributes to the production of apportionable income of the trade or business.

(i)Example (i): The taxpayer operates a multistate chain of stock brokerage houses.During the year, the taxpayer receives dividends on stock that it owns. The dividends are apportionable income.

(ii)Example (ii): The taxpayer is engaged in a multistate manufacturing and wholesaling business. In connection with that business, the taxpayer maintains special accounts to cover such items as workmen's compensation claims, etc. A portion of the moneys in those accounts is invested in interest-bearing bonds. The remainder is invested in various common stocks listed on national stock exchanges. Both the interest income and any dividends are apportionable income.

(iii)Example (iii): The taxpayer and several unrelated corporations own all of the stock of a corporation whose business consists solely of acquiring and processing materials for delivery to the corporate owners. The taxpayer acquired the stock in order to obtain a source of supply of materials used in its manufacturing trade or business. The dividends are apportionable income.

(iv)Example (iv): The taxpayer is engaged in a multistate heavy construction business. Much of its construction work is performed for agencies of the federal government and various state governments. Under state and federal laws applicable to contracts for these agencies, a contractor must have adequate bonding capacity, as measured by the ratio of its current assets (cash and marketable securities) to current liabilities. In order to maintain an adequate bonding capacity, the taxpayer holds various stocks and interest-bearing securities. Both the interest income and any dividends received are apportionable income.

(v)Example (v): The taxpayer receives dividends from the stock of its subsidiary or affiliate that acts as the marketing agency for products manufactured by the taxpayer. The dividends are apportionable income.

(vi)Example (vi): The taxpayer is engaged in a multistate glass manufacturing business. It also holds a portfolio of stock and interest-bearing securities, the acquisition and holding of which are unrelated to the manufacturing business. The dividends and interest income received are nonapportionable income.

(e)Patent and Copyright Royalties. Patent and copyright royalties are apportionable income when the patent or copyright with respect to which the royalties were received arose out of or was created in the regular course of the taxpayer's trade or business, or when the acquiring and holding the patent or copyright is or was related to the operation of the taxpayer's trade or business, or contributes to the production of apportionable income of the trade or business.

(i)Example (i): The taxpayer is engaged in the multistate business of manufacturing and selling industrial chemicals. In connection with that business, the taxpayer obtained patents on certain of its products. The taxpayer licensed the production of the chemicals in foreign countries, in return for which the taxpayer receives royalties. The royalties received by the taxpayer are apportionable income.

(ii)Example (ii): The taxpayer is engaged in the music publishing trade or business and holds copyrights on numerous songs. The taxpayer acquires the assets of a smaller publishing company, including music copyrights. These acquired copyrights are thereafter used by the taxpayer in its trade or business. Any royalties received on these copyrights are apportionable income.

(6)Proration of Deductions. In most cases, an allowable deduction of a taxpayer will be applicable to only the apportionable income arising from a particular trade or business or to a particular item of nonapportionable income. In some cases, an allowable deduction may be applicable to the apportionable incomes of more than one trade or business and to items of nonapportionable income. In such cases, the deduction shall be prorated among those trades or businesses and those items of nonapportionable income in a manner that fairly distributes the deduction among the classes of income to which it is applicable.

(a) Consistency in Reporting.

(i)Year-to-Year Consistency. In filing returns with Colorado, if the taxpayer departs from or modifies the manner of prorating any such deduction used in returns for prior years, the taxpayer shall disclose in the return for the current year the nature and extent of the modifications.

(ii)State-to-State Consistency. If the returns or reports filed by a taxpayer with all states to which the taxpayer reports under § 39-22-303.6, C.R.S., Article IV of the Multistate Tax Compact, or the Uniform Division of Income for Tax Purposes Act are not uniform in the application or proration of any deduction, the taxpayer shall disclose in its Colorado return the nature and extent of the variance.

(7) Consistency and Uniformity in Reporting.

(a)Year-to-Year Consistency. In filing returns with Colorado, if the taxpayer departs from or modifies the manner in which income has been classified as apportionable income or nonapportionable income in returns for prior years, the taxpayer shall disclose in the return for the current year the nature and extent of the modification.

(b)State-to-State Consistency. If the returns or reports filed by a taxpayer for all states to which the taxpayer reports under § 39-22-303.6, C.R.S., Article IV of the Multistate Tax Compact, or the Uniform Division of Income for Tax Purposes Act are not uniform in the classification of income as apportionable or nonapportionable income, the taxpayer shall disclose in its Colorado return the nature and extent of the variance.

39-22-303.6-2

Colorado Register, Vol 37, No. 14. July 25, 2014, effective 8/14/2014

37 CR 18, September 25, 2014, effective 10/15/2014

37 CR 19, October 10,2014, effective 10/30/2014

37 CR 22, November 25, 2014, effective 12/16/2014

38 CR 04, February 25, 2015, effective 3/17/2015

38 CR 07, April 10, 2015, effective 4/30/2015

38 CR 11, June 10, 2015, effective 6/30/2015

38 CR 22, November 25, 2015, effective 12/15/2015

38 CR 24, December 25, 2015, effective 1/14/2016

38 CR 24, December 25, 2015, effective 1/19/2016

39 CR 01, January 10, 2016, effective 1/30/2016

39 CR 16, August 25, 2016, effective 9/14/2016

40 CR 08, April 25, 2017, effective 5/15/2017

40 CR 12, June 25, 2017, effective 7/15/2017

40 CR 16, August 25, 2017, effective 9/14/2017

40 CR 23, December 10, 2017, effective 1/1/2018

41 CR 14, July 25, 2018, effective 8/14/2018

41 CR 20, October 25, 2018, effective 11/14/2018

42 CR 02, January 25, 2019, effective 12/18/2018

42 CR 02, January 25, 2019, effective 12/18/2018, expires 4/17/2019

42 CR 06, March 25, 2019, effective 4/14/2019

43 CR 04, February 25, 2020, effective 3/16/2020

43 CR 13, July 10, 2020, effective 6/2/2020

43 CR 17, September 10, 2020, effective 9/30/2020

44 CR 03, February 10, 2021, effective 3/2/2021

44 CR 07, April 10, 2021, effective 4/30/2021

44 CR 08, April 25, 2021, effective 5/15/2021

45 CR 01, January 10, 2022, effective 1/30/2022

45 CR 04, February 25, 2022, effective 3/17/2022

45 CR 05, March 10, 2022, effective 3/30/2022

46 CR 11, June 10, 2023, effective 5/2/2023

46 CR 09, May 10, 2023, effective 5/30/2023