AT&T Corp. v. Dept. of Rev. ( 2015 )

No. 34 September 11, 2015 691
IN THE SUPREME COURT OF THE
STATE OF OREGON
AT&T CORP.
& INCLUDIBLE SUBSIDIARIES,
Appellant,
v.
DEPARTMENT OF REVENUE,
Respondent.
(TC-RD 4814; SC S060150)
On appeal from the Oregon Tax Court.*
Henry C. Breithaupt, Judge.
Argued and submitted March 13, 2013.
John H. Gadon, Lane Powell PC, Portland, filed the brief
and argued the cause for appellant.
Marilyn J. Harbur, Assistant Attorney General, Salem,
argued the cause and filed the brief for respondent. With
her on the brief were Ellen F. Rosenblum, Attorney General,
and Douglas M. Adair and Darren Weirnick, Assistant
Attorneys General.
Before Balmer, Chief Justice, and Kistler, Walters,
Landau, Brewer, and Baldwin, Justices.**
BALDWIN, J.
The judgment of the Tax Court is affirmed.
____________
**  20 OTR 299 (2011)
**  Linder, J., did not participate in the decision of this opinion.
692 AT&T Corp. v. Dept. of Rev.
Case Summary: Taxpayer AT&T sought a refund for part of the Oregon cor-
porate excise taxes it had paid for tax years 1996 through 1999, asserting that
its sale of interstate and international phone and data transmissions should
not be counted in determining the fraction of AT&T’s income that Oregon can
tax. Under the relevant statute, ORS 314.665(4) (1999), those sales should be
counted only if the “income-producing activity” was entirely performed in Oregon
or if Oregon was the state with the greatest share of the “costs of performance”
for that activity. Based on its interpretation of what constituted an “income-
producing activity,” AT&T presented a cost study that purported to show that
Oregon did not have the greatest share of the “costs of performance.” The Tax
Court denied the refund claim, and AT&T appealed. Held: (1) The analysis of
an “income-producing activity” generally begins with each item of income —
each individual sale — and determines the relevant transactions and activity
associated with that sale; (2) the proper identification of the “income-producing
activity” will drive whether particular costs count as part of the “costs of perfor-
mance”; (3) AT&T failed to meet its burden of proof on the refund claim because
its cost study did not identify the correct income-producing activities and did not
correctly calculate the costs of performance for those activities.
The judgment of the Tax Court is affirmed.
Cite as 357 Or 691 (2015) 693
BALDWIN, J.
Appellant AT&T (together with its includible sub-
sidiaries) appeals a Tax Court judgment that denied AT&T’s
claim for a refund of a portion of the Oregon corporate excise
taxes it paid for tax years 1996 through 1999. AT&T Corp.
v. Dept. of Rev., 20 OTR 299 (2011) (Tax Court’s opinion).
The dispute concerns AT&T’s sale of interstate and inter-
national phone and data transmissions. We must decide
whether those sales are counted in determining the frac-
tion of AT&T’s income that Oregon can tax. Under the rel-
evant statute, ORS 314.665(4) (1999), those sales count as
Oregon sales if the “income-producing activity” was entirely
performed in Oregon or if Oregon was the state with the
greatest share of the “costs of performance” for that activity.
Based on its interpretation of what constituted an “income-
producing activity,” AT&T presented a cost study that pur-
ported to show that Oregon did not have the greatest share
of the “costs of performance.” The Department of Revenue
(department) challenged AT&T’s interpretation of “income-
producing activity” and attacked the validity of its cost
study. The Tax Court ruled in favor of the department.
As we will explain, we conclude that AT&T did
not use a correct definition of “income-producing activity.”
AT&T’s proposed interpretation is network-based; it focused
on the operation of its network as a whole. The correct
understanding, however, is transaction-based; it examines
individual sales to customers. AT&T thus failed to meet its
burden of proof, because it did not correctly calculate the
“costs of performance” for the correct “income-producing
activities.” Accordingly, we affirm.
I. BACKGROUND
A.  The Taxpayer
AT&T, the taxpayer, is a global telecommunica-
tions company. It provides voice and data telecommunica-
tions services over the global AT&T network, which AT&T
constructed, maintains, and operates. The network works
together as an integrated whole, and it is used to provide
all of AT&T’s services at issue. In the United States, the
network provides multiple pathways that a call may take,
694 AT&T Corp. v. Dept. of Rev.
depending on traffic on the overall AT&T network. The path
a particular call may take is not known in advance and is
determined by a complex computer system that chooses the
path in milliseconds. The network is managed from the
AT&T Global Network Operations Center in Bedminster,
New Jersey.
AT&T does not generally provide “last-mile service”
to its customers over its own facilities. Instead, it provides
service on its own facilities only from one “point of presence”
to another “point of presence.” The last-mile service from
the point of presence to the caller or the recipient is provided
over the facilities of a local exchange carrier. AT&T pays the
local exchange carriers an access charge for this last-mile
service.
B.  The Statute and Rule
This case involves income tax. For those taxpayers
that do business in more than one jurisdiction, states gener-
ally may tax a representative fraction of the taxpayer’s total
income. The fraction of income that a particular state can tax
is determined, in part, by the amount of a taxpayer’s sales
in that particular state. Specifically, that part of the calcu-
lation requires comparing “in state” sales to the taxpayer’s
total sales. In this case, we must determine whether sales
are considered to be “in this state” under ORS 314.665(4)
(1999).1 For purposes of income tax, that statute defines
certain sales as Oregon sales depending on the location of
the “income-producing activity.” The sales are in Oregon if
(1) the income-producing activity occurs entirely in Oregon,
or (2) Oregon’s share of the “costs of performance” of that
income-producing activity is greater than any other state.
Specifically, ORS 314.665(4) provides:
“Sales, other than sales of tangible personal prop-
erty, are in this state if (a) the income-producing activity
1
In general, all Oregon statutes and administrative rules discussed in this
opinion are the 1999 versions, which were unchanged in their relevant parts
during the tax years at issue here. The exception is OAR 150-314.665(4), in which
we refer to the 2008 version containing amendments effective January 1, 2007:
AT&T conceded in the Tax Court that the 2007 amendments to that rule applied
retroactively to the tax years at issue here, and the parties and the Tax Court
used that version.
Cite as 357 Or 691 (2015) 695
is performed in this state; or (b) the income-producing
activity is performed both in and outside this state and a
greater proportion of the income-producing activity is per-
formed in this state than in any other state, based on costs
of performance.”
The correct application of that statute depends in
large part on the meaning of two terms: “income-producing
activity” and “costs of performance.” The department has
promulgated a rule that defines those terms, among other
things. Briefly, the definition of “income-producing activity”
is (in part):
“The term ‘income-producing activity’ applies to each
separate item of income and means the transactions and
activity directly engaged in by the taxpayer in the regular
course of its trade or business for the ultimate purpose of
obtaining gains or profit.”
OAR 150-314.665(4) (2). The second term, “costs of perfor-
mance,” is defined in part as follows:
“The term ‘costs of performance’ means direct costs
determined in a manner consistent with generally accepted
accounting principles and in accordance with accepted con-
ditions or practices in the trade or business of the taxpayer.”
OAR 150-314.665(4) (4).
C.  Procedural Posture
1.  AT&T’s Request for Refund
This action began when AT&T sought a refund
on the taxes that it paid for tax years 1996 through 1999.
AT&T filed amended tax returns seeking a refund. AT&T
argued that the relevant statute and rule, correctly under-
stood, indicated that its “income-producing activities” were
some of the business activities associated with its network
operations, because the network was necessary for AT&T to
provide interstate and international transmissions of voice
and data for consumers and businesses.2
2
AT&T admitted that some of its other business activities effectively did
not qualify as “income-producing activities.” It also admitted that the “costs of
performance” for intrastate consumer and business calls and data were primarily
incurred in Oregon, and so those sales were taxable here.
696 AT&T Corp. v. Dept. of Rev.
Based on its interpretation of the law, AT&T offered
a cost study of the “costs of performance” for what it consid-
ered to be its “income-producing activities.” The cost study
was prepared for AT&T by BI Solutions Group, LLC—more
specifically, by James Allen, a manager at BI Solutions and
a specialist in cost accounting, who testified as an expert
witness. The printed version of the study, including the asso-
ciated schedules, is almost 300 pages long; our discussion
here gives only a brief overview, often simplifying details
that are not relevant to our holding.
Because AT&T’s understanding of “income-producing
activity” indicated that its activities were performed both
in-state and out-of-state, the cost study analyzed the “costs
of performance” for each activity. It then compared the costs
incurred in Oregon to those incurred in New Jersey.3 The
study purported to show that the costs incurred in New
Jersey exceeded the costs incurred in Oregon in every
instance. Accordingly, AT&T argued that the requirement
of ORS 314.665(4) for including the relevant sales as Oregon
sales had not been met: Oregon did not have a “greater pro-
portion” of the costs of performance than any other state.
As a result, AT&T’s position is that none of its relevant rev-
enues from sales—not even those revenues from Oregon
customers—count as being “in” Oregon.
The study consists of two parts. In the first part,
the cost study analyzed AT&T’s costs based on its interpre-
tation of the statute and rule. The second part of the study,
anticipating the department’s position, analyzed AT&T’s
costs incurred for “Oregon demand.”
The first part of the cost study began by identifying
what it considered to be the “separate item[s] of income,” a
term used in the rule defining “income-producing activity.”
The cost study concluded that the items of income were “the
Network Telecommunications Services” that AT&T pro-
vided to its customers. Because AT&T provided many such
3
AT&T chose to compare Oregon costs to New Jersey costs because New
Jersey was where its Global Network Operations Center was located. Under the
statute, AT&T only needed to show that some state somewhere had a “greater
proportion” of the costs of performance for the income-producing activity. ORS
314.665(4).
Cite as 357 Or 691 (2015) 697
services, however, the cost study categorized them into “ser-
vice families.” The service families used in the cost study
were consumer voice, business voice, and business data,
each of which was divided into interstate and international
services.
The cost study then identified what AT&T consid-
ered to be the relevant income-producing activities, which
were certain of AT&T’s business activities. Fundamentally,
these activities were based around AT&T’s operation of the
network as a whole. Of those, the cost study focused on those
business activities whose costs would, in AT&T’s estimation,
qualify as “direct costs” for the “costs of performance” part of
the analysis. The three applicable income-producing activi-
ties identified by AT&T were: “service activation” (which
Allen summarized as “setting up the customers and having
them able to utilize AT&T’s network telecommunication ser-
vices”), “service assurance” (meaning “work activity asso-
ciated with maintaining the availability of the network”),
and “service execution” (meaning “the physical network,”
“the assets by which AT&T provides its network telecom-
munications services”). In other words, AT&T’s analy-
sis of its income-producing activities was system-based or
network-based.4
Based on those classifications, AT&T’s cost study
generally analyzed the “costs of performance” for each
4
It is not clear to what extent the cost study actually depended on this par-
ticular classification of “income-producing activities.” Although the cost study’s
written description asserts that the relevant income-producing activities are
“service activation,” “service assurance,” and “service execution,” the cost study
itself breaks costs down according to a completely different set of categories: “net-
work and other costs” (including network engineering, network support, network
services, and field operations), “depreciation and amortization,” and “customer
care.” Those are the only categories for which the cost study actually calculates
costs; nowhere does the cost study identify the direct costs per year for “service
activation,” for example. And the cost categories themselves (network, deprecia-
tion, customer care) are not simply different names for AT&T’s identified income-
producing activities. The study indicates that those cost categories apply to more
than one income-producing activity: Both “service activation” and “service assur-
ance” include some share of “customer care” costs, for example, while “network
and other costs” seemingly apply to all three identified “income-producing activ-
ities.” (The cost study contains a table that lists the cost categories involved in
each “income-producing activity,” but that table does not contain any row identi-
fying the cost categories for “service execution.” Presumably “service execution”
involves both some share of “network and other costs” as well as “depreciation and
amortization.”)
698 AT&T Corp. v. Dept. of Rev.
“income-producing activity” in the following manner: The
study first identified all of AT&T’s costs that it believed
qualified as “direct costs” under the rule, and specifically
identified those costs incurred in Oregon and New Jersey.
In particular, the study excluded the access charges, which
it concluded did not qualify as a “direct cost.” The cost study
then attributed the direct costs to the “income-producing
activities” that it had concluded were recognizable under
the statute and rule. Finally, the study attributed those
costs to the service families that it had identified as “sepa-
rate item[s] of income.” The result of those calculations pur-
ported to identify the direct costs for each income-producing
activity as to each item of income. The summary calcula-
tions, however, were only by year, by service family (that
is, AT&T’s classification of “item of income”), and by costs
in Oregon and New Jersey. Here, for example, are the cost
study’s summary calculations for 1999:
Oregon Costs New Jersey Costs
Business
Voice
Interstate $ 15,770,292 $ 260,731,804
Int’l $ 911,698 $ 18,963,486
Data
Interstate $ 15,715,660 $ 198,100,125
Int’l $ 437,258 $ 5,511,749
Consumer
Voice
Interstate $ 3,698,467 $ 70,274,114
Int’l $ 1,113,686 $ 20,778,559
Because the cost study showed similar results
for the other tax years, AT&T argued that it had demon-
strated that the New Jersey “costs of performance” exceeded
Oregon costs. Accordingly, it maintained, the receipts from
interstate and international voice and data should not be
included in the numerator of the Oregon sales factor.
Cite as 357 Or 691 (2015) 699
As we noted, the cost study contained two parts.
In the second part of its cost study, the study analyzed
the costs associated with “Oregon demand,” to address the
department’s anticipated legal analysis.5 This second part of
the cost study functionally paralleled the first part. Again,
in general terms, the study took the figures for direct costs
that it had attributed to the “income-producing activities”
for each item of income, and then calculated (1) the share
of Oregon costs that had been incurred to support Oregon
demand, and (2) the share of New Jersey costs that had
been incurred to support Oregon demand. AT&T’s cost
study again purported to show that, even under an “Oregon
demand” analysis, the “costs of performance” in New Jersey
were greater than they were in Oregon. Here, for example,
are its calculations for 1999:
OR Cost for OR NJ Costs for OR
Demand Demand
Business
Voice
Interstate $ 634,702 $ 2,638,468
Int’l $ 55,649 $ 190,560
Data
Interstate $ 391,277 $ 1,994,880
Int’l $ 10,887 $ 55,504
Consumer
Voice
Interstate $ 318,818 $ 709,725
Int’l $ 88,889 $ 210,008
If AT&T’s analysis was both legally and factually
sound, then the relevant sales would not count as Oregon
5
The cost study does not specifically define what it considers “Oregon
demand,” but Allen in his testimony described what it meant, at least in the
context of phone calls. Based on rules derived from sales and use taxes, a call
would be counted as an Oregon call if Oregon was the state for at least two of the
following three criteria: the state where the call began, the state where the call
ended, or the state where the transaction was billed.
700 AT&T Corp. v. Dept. of Rev.
sales, and Oregon would not be entitled to tax as much of
AT&T’s income. For example, AT&T’s original 1996 tax
return indicated that Oregon could tax 0.7621 percent of
AT&T’s total income of $7.3 billion, while AT&T’s amended
1996 tax return suggested that Oregon could tax only 0.4303
percent of that $7.3 billion. Similar differences would have
applied to the other tax years.
The department opposed the claim for a refund.
The department argued for a transaction-based application
of “income-producing activity”; namely, that the relevant
“income-producing activity” here was the activity that pro-
duced each individual interstate and international phone and
data transmission billed to an Oregon customer. As the depart-
ment stated in its pretrial memorandum to the Tax Court:
“The proper construction of ‘income producing activity’ * * *
applies to each item of income from each call billed on a
per minute basis or each flat rate subscription. Thus, the
income producing activity is AT&T’s connection of each
Oregon long distance call to the network.”
The department maintained that the only “costs of perfor-
mance” for those individual transactions—meaning “direct
costs,” OAR 150-314.665(4) (4)—were (1) the cost of the elec-
tricity for the calls and data transmission, and (2) the access
charges levied by the local exchange carrier for connecting
the customer with AT&T’s network. The majority of those
costs were incurred in Oregon, the department argued, and
so the sales should be counted as Oregon sales. The result
would be that AT&T’s tax liability to Oregon would remain
unchanged from its initial tax returns.
In addition, the department offered expert testi-
mony critical of AT&T’s cost study. Michael Starkey, a con-
sultant who specialized in telecommunications cost analy-
sis, testified and prepared a rebuttal report. He asserted
that the department’s transaction-based interpretation of
“income-producing activity” was correct, and he disagreed
with AT&T’s network-based interpretation.
The Tax Court agreed with the department and
denied AT&T’s request for a refund. The court first deter-
mined that the statutes and regulations required a three-
step analysis:
Cite as 357 Or 691 (2015) 701
“[T]he analysis must begin with transactions that are or
include ‘income producing activit[ies].’ The next step is to
determine the gross receipt from that transaction. The final
step is to determine where the direct costs of performance
occurred geographically, as to the transaction or activity.”
20 OTR at 304-05 (second alteration in original; footnote
omitted).
At the first step that it had identified, the court con-
cluded that the statutes and regulations required a focus
on individual transactions with customers, while AT&T
instead had “focuse[d] on entire groups or classes of trans-
actions.” Id. at 306. AT&T’s analysis was deficient, the court
explained, because it “ha[d] begun its analysis with the
wrong cost object [and] ha[d] not attempted to determine
where costs of particular transactions are incurred.” Id. at
307.6
Although the court concluded that that was enough
to deny AT&T’s refund claim, it went on to consider other
questions. Id. Because the court had agreed with the
department that each separate phone call or flat-rate bill-
ing was an income-producing activity, the court rejected
AT&T’s argument that the costs of performance—by rule,
the direct costs—were those associated with operating
the network generally. Id. at 307-09. The court apparently
agreed with the department that the direct costs were only
those costs that AT&T incurred in carrying a particular
individual phone call—basically the electricity consumed
by the call and the access charges that AT&T paid to the
local exchange carrier on each end of the transaction. See
id. at 309 (concluding that the department’s interpretation
“has a number of points in its favor”). The Tax Court spe-
cifically rejected AT&T’s argument that the access charges
paid to local exchange carriers did not count as direct costs
for purposes of the “costs of performance” analysis. Id. at
309-11.
6
The department had argued that one should begin with Oregon calls only.
The Tax Court characterized that as a permissible “shortcut” that the depart-
ment could take with “its analysis”; “the department is simply starting with a
smaller census” of possible revenues, and doing so could only benefit AT&T. 20
OTR at 305. We note, however, that the department did not present its own cost
study. The only cost study before the court was that prepared by AT&T.
702 AT&T Corp. v. Dept. of Rev.
II. ANALYSIS
A.  Standard of Review and Interpretive Methodology
AT&T has appealed the decision of the Tax Court. Our
review is “limited to errors or questions of law or lack of substan-
tial evidence in the record to support the tax court’s decision or
order.” ORS 305.445. The appeal involves AT&T’s request for
a refund, and as the party seeking affirmative relief, AT&T
bears the burden of proof. See ORS 305.427 (in Tax Court pro-
ceedings “and upon appeal therefrom,” “[t]he burden of proof
shall fall upon the party seeking affirmative relief”).
To address the issues before us, we must interpret
Oregon statutes and administrative rules. In both instances,
we apply the same methodology: We first consider the text
and context, and then (in the case of statutes) examine any
relevant legislative history. See State v. Gaines, 346 Or 160,
171-72, 206 P3d 1042 (2009) (explaining that methodology
for statutes); Wetherell v. Douglas County, 342 Or 666, 678,
160 P3d 614 (2007) (court applies its statutory interpretation
methodology to administrative rules). In the case of admin-
istrative rules, we ordinarily defer to the adopting agency’s
interpretation if that interpretation is plausible and is not
inconsistent with the rule in its context or with some other
source of law. See Crystal Communications, Inc. v. Dept. of
Rev., 353 Or 300, 311, 297 P3d 1256 (2013) (stating princi-
ple); Don’t Waste Oregon Com. v. Energy Facility Siting, 320
Or 132, 142, 881 P2d 119 (1994) (same).
B.  Uniform Division of Income for Tax Purposes Act
The statute at issue here, ORS 314.665(4), is a part
of Oregon’s version of the Uniform Division of Income for
Tax Purposes Act (UDITPA). In this state, UDITPA is codi-
fied at ORS 314.605 to 314.675.
Strictly speaking, Oregon’s UDITPA statutes apply
here only by administrative rule. AT&T is a public utility, see
ORS 314.610(6),7 and so it is taxed under ORS 314.280(1).8
7
ORS 314.610(6) defines a “public utility” to include “any business entity
whose principal business is * * * the transmission of communications.”
8
A provision of Oregon’s UDITPA adds that UDITPA does not apply to public
utilities. ORS 314.615. “Taxpayers engaged in activities as a financial organization
or public utility shall report their income as provided in ORS 314.280 and 314.675.”
Cite as 357 Or 691 (2015) 703
The latter statute generally authorizes the department to
determine whether and when a taxpayer may use what it
terms the “the segregated method of reporting or the appor-
tionment method of reporting.”9 The department promul-
gated rules under ORS 314.280 that, for purposes of the
apportionment method, have largely incorporated Oregon’s
version of UDITPA. Crystal Communications, 353 Or at
303-04 (so noting); see OAR 150-314.280-(A) - (F) (incor-
porating various UDITPA statutes and administrative
rules). AT&T here used the apportionment method of
reporting, and the department does not question the pro-
priety of AT&T using that method. Accordingly, we turn to
UDITPA.
A brief overview of UDITPA may provide some help-
ful background. UDITPA was intended to address the prob-
lem of how to attribute income to taxpayers who do business
in more than one state. It is often difficult or impossible for a
taxpayer doing business in more than one state to attribute
a particular dollar of income to a particular state. See, e.g.,
Walter Hellerstein, State Taxation of Corporate Income from
Intangibles: Allied-Signal and Beyond, 48 Tax L Rev 739,
745 (1993). The types of businesses that cannot attribute
dollars to particular states are generally known as unitary
businesses; they are “businesses in which a portion of the
business done within the state is dependent upon or con-
tributes to the operation of the business without the state.”
Crystal Communcations, 353 Or at 303 (internal quotation
marks and citations omitted); see Hellerstein, 48 Tax L Rev
9
ORS 314.280 provides, in part:
“(1)  If a taxpayer has income from business activity * * * as a public util-
ity (as defined respectively in ORS 314.610 * * * (6)) which is taxable both
within and without this state (as defined in ORS 314.610(8) and 314.615),
the determination of net income shall be based upon the business activity
within the state, and the Department of Revenue shall have power to permit
or require either the segregated method of reporting or the apportionment
method of reporting, under rules and regulations adopted by the department,
so as fairly and accurately to reflect the net income of the business done
within the state.
“(2) The provisions of subsection (1) of this section dealing with the
apportionment of income earned from sources both within and without the
State of Oregon are designed to allocate to the State of Oregon on a fair and
equitable basis a proportion of such income earned from sources both within
and without the state. * * *”
704 AT&T Corp. v. Dept. of Rev.
at 745-46.10 To tax unitary businesses, states use what is
known as formulary apportionment. Rather than attempt to
attribute individual dollars of income to particular states,
formulary apportionment uses a formula to estimate the
fraction of the taxpayer’s total income that can be attributed
to each state. See Hellerstein, 48 Tax L Rev at 745; Walter
Hellerstein, State Income Taxation of Multijurisdictional
Corporations: Reflections on Mobil, Exxon, and H.R. 5076,
79 Mich L Rev 113, 117 (1980); Frank M. Keesling and John
S. Warren, The Unitary Concept in the Allocation of Income,
12 Hastings LJ 42, 43 (1960).11
UDITPA was intended to provide a uniform method
for the states to determine the specific fraction to be used
for the formulary apportionment. See, e.g., William J. Pierce,
The Uniform Division of Income for State Tax Purposes, 35
Taxes 747, 748 (1957) (noting the “amazing variety of for-
mulas” then being used by the states, creating the danger
that a taxpayer would be either double taxed or not taxed on
everything). If UDITPA were adopted by every state, then
its common formula would mean that all of a taxpayer’s
income would be taxed in some state, but none of it would
be taxed by more than one state. Pierce, 35 Taxes at 748 (so
noting).
The apportionment formula used by UDITPA uti-
lizes certain factors to estimate the extent to which a tax-
payer’s income may be attributed to a particular state.
See, e.g., Steve Christensen, Formulary Apportionment:
More Simple—On Balance Better? 28 L & Pol’y in Int’l
Bus 1133, 1147 (1997). The three factors used in UDITPA
10
Unitary businesses are in contrast to nonunitary businesses, which are
“business entities that are connected by common ownership but that exist inde-
pendently and in different states.” Crystal Communications, 353 Or at 303.
Nonunitary businesses are taxed using the segregated method of reporting men-
tioned in ORS 314.280. Id.
11
If a taxpayer does not operate a unitary business, then a state generally
lacks the constitutionally necessary basis to use apportionment to tax the income
that the taxpayer earned outside of the state. See, e.g., OAR 150-314.610(1)-(A) (6)
(discussing constitutional limits and “unitary business principle”). On the other
hand, if the taxpayer does operate a unitary business, then taxing only those
parts of the business operations that are located in-state is to “endeavor[ ] to treat
separately what is, in fact, inseparable.” George H. Weissman, Unitary Taxation:
Its History and Recent Supreme Court Treatment, 48 Albany L Rev 47, 50-51
(1983) (internal quotation marks and citation omitted).
Cite as 357 Or 691 (2015) 705
apportionment are the property factor, the payroll factor,
and the sales factor. Each factor is itself a fraction:
• the property factor is the ratio of in-state property
to total property,
• the payroll factor is the ratio of in-state payroll to
total payroll, and
• the sales factor is the ratio of in-state sales to total
sales.
See UDITPA §§ 10, 13, 15 (defining each factor); ORS
314.655 - 314.665 (Oregon’s version of those factors). Under
UDITPA, the fractions representing the three factors are
added together and divided by three. UDITPA § 9; compare
ORS 314.650(1) (during the relevant tax years, Oregon dou-
bled the sales factor before adding, and then divided by four).
The result is the fraction of the taxpayer’s total income that
can be taxed by this state.
The first two factors, the property and payroll fac-
tors, estimate the state’s share of responsibility for the income
stream by focusing on production. Those two factors track
in-state capital and labor respectively, so they reflect obvious
connections with the taxing state. See, e.g., Hellerstein, 48
Tax L Rev at 754. The third factor, sales, generally tracks
the extent to which the taxpayer takes advantage of the tax-
ing state’s market. See Powerex Corp. v. Dept. of Rev., 357 Or
40, 64-65, 346 P3d 476 (2015); John A. Swain, Reforming the
State Corporate Income Tax: A Market State Approach to the
Sourcing of Service Receipts, 83 Tul L Rev 285, 288 (2008);
Christensen, 28 L & Pol’y in Int’l Bus at 1134.
C.  UDITPA’s Sales Factor
As noted, this case involves the sales factor. We
must begin by defining sales. Generally, “sales” are “gross
receipts of the taxpayer.” UDITPA § 1(g); ORS 314.610(7)
(both excluding gross receipts that are not allocated under
other statutes).12
12
That is the general definition. For purposes of the sales factor, some
other types of gross receipts are excluded from the definition of “sales.” See ORS
314.665(6) (listing additional exclusions). This case does not involve any dispute
over those exclusions from the definition of “sales.” For purposes of this opinion,
it is adequate to treat “sales” as simply being gross receipts.
706 AT&T Corp. v. Dept. of Rev.
The sales factor generally is the taxpayer’s in-state
sales divided by the taxpayer’s total sales. UDITPA section
15 and ORS 314.665(1), which are identical, specifically
state:
“The sales factor is a fraction, the numerator of which is
the total sales of the taxpayer in this state during the tax
period, and the denominator of which is the total sales of
the taxpayer everywhere during the tax period.”
See also Powerex, 357 Or at 42, 60.
The denominator of the sales factor begins and ends
by counting the gross receipts from all sales by the taxpayer
everywhere. The numerator, however, is more complex. As we
will explain, the relevant statute begins at the same point as
the denominator: with all sales by the taxpayer everywhere.
It then sets out an analytical method to determine which of
those sales will be counted as sales “in this state.” This ana-
lytical method divides all of taxpayer’s sales into two classes:
sales of tangible personal property, and all other sales, i.e.,
“sales, other than sales of tangible personal property.” See
ORS 314.665(2), (4); Powerex, 357 Or at 43 n 3, 60-61. For
each class, the statute then prescribes which of those sales
count as in-state sales. If the sales are of tangible personal
property, then one set of criteria are used to determine which
of those sales count as sales “in this state.” ORS 314.665(2);
see Powerex, 357 Or at 43. If the sales are of anything other
than tangible personal property, then another set of criteria
are used to determine which of those sales count as sales “in
this state.” ORS 314.665(4); see Powerex, 357 Or at 43. If all
sales in both classes meet the relevant criteria so that they
are all considered to be “in this state,” then the numerator of
the sales factor will be identical to the denominator, and the
sales factor will be 1.0 (that is, 100 percent).
1.  Sales of Tangible Personal Property
Sales of tangible personal property are controlled
by ORS 314.665(2) (UDITPA section 16). Although that pro-
vision is not at issue here, it serves as useful context.
The Oregon statutory text provides:
“(2)  Sales of tangible personal property are in this
state if:
Cite as 357 Or 691 (2015) 707
“(a)  The property is delivered or shipped to a pur-
chaser, other than the United States Government, within
this state regardless of the f.o.b. point or other conditions of
the sale; or
“(b)  The property is shipped from an office, store, ware-
house, factory, or other place of storage in this state and
(A) the purchaser is the United States Government or (B) the
taxpayer is not taxable in the state of the purchaser.”
ORS 314.665(2); see also UDITPA § 16 (essentially identical).
Thus, ORS 314.665(2) sets out the criteria to be
applied to all of a taxpayer’s sales of tangible personal
property to determine which (if any) count as sales “in this
state.” The statute focuses on individual sales to purchasers.
The general rule counts an individual sale as “in this state”
if this state is where the property is delivered or shipped to
the purchaser. See Powerex, 357 Or at 46-52 (analyzing stat-
ute in detail). As a result, this part of the sales factor gener-
ally reflects that state’s contribution as a market toward the
taxpayer’s income.
The statute does not always reflect the market state’s
contribution, however. Sales of tangible personal property
are not attributed to the market state in two instances: when
the United States Government is a purchaser, and when the
taxpayer cannot be taxed in the purchaser’s state. The lat-
ter exception is particularly significant, because it shows
that UDITPA emphasized the interest of making all of the
taxpayer’s income taxable somewhere over the interest of
reflecting the market state’s contribution to the transaction.
See Jerome R. Hellerstein, Walter Hellerstein, and John A.
Swain, 1 State Taxation ¶ 9.18[1][b][i], 9-259 (3d ed 2014)
(noting policy justification to avoid possibility of “ ‘nowhere’
income”). In short, sales of tangible personal property are
generally—but not invariably—apportioned to the market
state.
2.  Sales Other Than Sales of Tangible Personal
Property
The second sales factor provision of UDITPA, and the
one at issue here, is the catchall provision. While the first fac-
tor deals with sales of tangible personal property, the second
708 AT&T Corp. v. Dept. of Rev.
factor deals with all other sales—“sales, other than sales of
tangible personal property.” Again, ORS 314.665(4) provides:
“(4)  Sales, other than sales of tangible personal prop-
erty, are in this state if (a) the income-producing activity
is performed in this state; or (b) the income-producing
activity is performed both in and outside this state and a
greater proportion of the income-producing activity is per-
formed in this state than in any other state, based on costs
of performance.”
See also UDITPA § 17 (essentially identical). The framers
of UDITPA did not provide any commentary for UDITPA
section 17.
In any particular case, how ORS 314.665(4) will
apply depends largely on the precise meaning of two terms:
“income-producing activity” and “costs of performance.”
Here, the department urges that “income-producing activity”
is transaction focused and applies to each individual phone
call or separate monthly billing. AT&T, on the other hand,
contends that “income-producing activity” refers to broad
swaths of its business. Its system-based or network-based
interpretation, if accepted, would cause the statute to assign
large chunks of revenue to a single state.
We make two observations about the text of ORS
314.665(4). First, AT&T correctly notes that the provision
does not look to the market where the sales occur. There
is nothing specified about the geographic location of the
taxpayer’s customers, which one would expect from a fac-
tor focused on a state’s contribution to the market. Instead,
the provision looks to where the taxpayer effectively pro-
duces the income. The state where the taxpayer conducts its
“income-producing activity” for a sale or class of sales may
or may not happen to be the market state. Here, just as we
noted in connection with certain sales of tangible personal
property, the drafters of UDITPA apparently chose to run
the risk that those sorts of sales would not reflect the mar-
ket state’s contribution.
The second point, by contrast, is that ORS 314.665(4)
seems to connect the term “income-producing activity” with
particular “sales.” The statutory purpose is to assign the
income from sales to particular states, and to do that, the
Cite as 357 Or 691 (2015) 709
provision directs us to identify the activity that produces
that income—the income from that particular sale. The
statute thus suggests that the focus may be on individual
sales. Such a reading would parallel the treatment of sales
of tangible personal property under ORS 314.665(2): Just
as that statute attributes each individual sale of tangible
personal property to a particular state, so ORS 314.665(4)
arguably attributes other individual sales to a particular
state. That would imply, then, that the income-producing
activity in ORS 314.665(4) means the activity that produces
the income associated with a particular sale.
In saying that, we do not suggest that that is the
only possible way to read the provision. Commentators have
routinely criticized UDITPA section 17 for its ambiguity:
“[T]he commentators have found the rules to be ‘confus-
ing and indefinite’ and plagued by ‘vagueness,’ ‘ambiguity,’
‘substantial debate,’ ‘lack of clear guidance,’ ‘whipsaw[ing],’
‘tremendous flexibility, and hence [tax planning] opportu-
nity,’ ‘frequent litigation,’ ‘inconsistency,’ and ‘confusion for
taxpayers and taxing authorities alike.’ ”
Swain, 83 Tul L Rev at 306 (second and third alterations in
original; footnotes omitted). While there is room for doubt
at the statutory level, then, it appears to us that the depart-
ment’s interpretation of the statute is more likely to be
within the range of permissible interpretations.
D.  OAR 150-314.665(4)
As noted, the department adopted an administra-
tive rule, OAR 150-314.665(4) (2007), that defines “income-
producing activity” and “costs of performance” and that
otherwise attempts to clarify how ORS 314.665(4) should be
applied. That rule is almost identical to a model regulation
that had been previously promulgated by the Multistate Tax
Commission. See Multistate Tax Commission Allocation
and Apportionment Regulation IV.17 (1997), available at
http://bit.ly/1gbN3zv (accessed July 1, 2015) (essentially
identical to OAR 150-314.665(4)).13 Neither party asserts
13
The Multistate Tax Commission amended its model regulation in 2007,
but the department had not incorporated those changes into the version of OAR
150-314.665(4) applicable to this case. See Multistate Tax Commission Allocation
and Apportionment Regulations at 1, available at http://bit.ly/1RSr38z (accessed
July 14, 2015) (noting amendments to Regulation IV.17).
710 AT&T Corp. v. Dept. of Rev.
that the department’s rule is invalid or inconsistent with
ORS 314.665(4). Accordingly, we now turn to that rule for
guidance.
The first subsection of OAR 150-314.665(4) provides
a detailed and informative restatement of ORS 314.665(4)
itself:
“(1)  In General. ORS 314.665(4) provides for the
inclusion in the numerator of the sales factor of gross
receipts from transactions other than sales of tangible
personal property (including transactions with the United
States Government); under this section gross receipts are
attributed to this state if the income producing activity that
gave rise to the receipts is performed wholly within this
state. Also, gross receipts are attributed to this state if,
with respect to a particular item of income, the income pro-
ducing activity is performed within and without this state
but the greater proportion of the income producing activity
is performed in this state, based on costs of performance.”
OAR 150-314.665(4) (1).
We read that subsection to establish the appropri-
ate framework to be used to determine whether sales other
than sales of tangible personal property are included in the
numerator of the sales factor. The subsection first directs
us to begin with the gross receipts from sales of other than
tangible personal property. Next, we identify the income-
producing activity that generated those gross receipts. We
then determine where that income-producing activity was
performed. If the activity was entirely performed in Oregon,
then the associated gross receipts are counted in the Oregon
sales factor’s numerator. If the activity was performed in
more than one state, then we determine which state had the
largest share of that income-producing activity, based on the
direct costs of producing the sale or sales.14 If more of that
income-producing activity occurred in Oregon than in any
other state, then all of the income is counted in the Oregon
numerator. Otherwise, none of it is.
14
This does not necessarily require evidence of the costs of performance in
every state. If a taxpayer is attempting to prove that sales of other than tangible
personal property should not be counted in the Oregon numerator, then it is suf-
ficient for the taxpayer to show that at least one state has a greater share of the
costs of performing the related income-producing activity.
Cite as 357 Or 691 (2015) 711
The first question, then, involves the meaning of
“income-producing activity.” Even before we turn to the
subsection of the rule that defines the term, we can make
certain generalizations about it. The statutory term itself
indicates that an “income-producing activity” is something
that produces income for the taxpayer. Similarly, the sub-
section that establishes the analytical framework adds that
an “income-producing activity” is something that generates
“gross receipts” and results in an “item of income.” See OAR
150-314.665(4) (1) (focusing on whether “the income pro-
ducing activity that gave rise to the receipts” meets certain
conditions or whether, “with respect to a particular item of
income, the income producing activity” meets other condi-
tions); see also OAR 150-314.665(4) (2) (“the term ‘income
producing activity’ applies to each separate item of income”).
The subsection defining “income-producing activ-
ity” provides as follows:
“(2)  Income Producing Activity; Defined. The term
‘income producing activity’ applies to each separate item
of income and means the transactions and activity directly
engaged in by the taxpayer in the regular course of its
trade or business for the ultimate purpose of obtaining
gains or profit. Except as provided otherwise in this rule,
such activity does not include transactions and activities
performed on behalf of a taxpayer, such as those conducted
on its behalf by an independent contractor. Accordingly,
income producing activity includes but is not limited to the
following:
“(a)  The rendering of personal services by employees
or the utilization of tangible and intangible property by the
taxpayer in performing a service.
“(b)  The sale, rental, leasing, franchising, licensing or
other use of real property.
“(c)  The rental, leasing, franchising, licensing or other
use of tangible personal property.
“(d)  The sale, franchising, licensing or other use of
intangible personal property. The mere holding of intangi-
ble personal property is not, of itself, an income producing
activity.”
OAR 150-314.665(4) (2).
712 AT&T Corp. v. Dept. of Rev.
That definition adds that an income-producing
activity itself includes “transactions and activity * * * by the
taxpayer.” OAR 150-314.665(4) (2). The “transactions and
activity” that constitute the “income-producing activity”
must have three qualities: they must be “directly engaged in
by the taxpayer”; they must be done “in the regular course of
[the taxpayer’s] trade or business”; and they must have the
“ultimate purpose of obtaining gains or profit.” Id.There is, however, an additional requirement.
OAR 150-314.665(4) (2) states, “The term ‘income produc-
ing activity’ applies to each separate item of income[.]” The
term “item of income” is not defined in the rules. Its ordi-
nary meaning is not helpful in this context, and we cannot
find any evidence that “item of income” is a term of art in
the accounting industry.
The department takes the position that “item of
income” means an individual exchange between a buyer and
a seller: “Each particular or separate item of income is a
sale—a transaction—an exchange between a buyer and a
seller.” Whether the transmissions are sold individually or
are sold in bulk, so to speak (for a flat monthly rate), is irrel-
evant to the analysis. The department’s position regarding
the meaning of “item of income” is plausible and not incon-
sistent with the text of the rule in its context, or with the
statute, or with any other source of law. Accordingly, we
defer to that interpretation. See Don’t Waste Oregon Com.,
320 Or at 142.
That narrow interpretation of “item of income” nec-
essarily limits the definition of “income-producing activity.”
To identify the income-producing activity, we must identify
for each “item of income”—for each individual sale—the
“transactions and activity directly engaged in by the tax-
payer in the regular course of its trade or business for the
ultimate purpose of obtaining gains or profit.” OAR 150-
314.665(4) (2). The analysis thus generally begins with each
item of income—each individual sale—and determines the
relevant transactions and activity associated with that sale.
The result is an “income-producing activity.”
Whatever ambiguity may exist in the statutory text
of ORS 314.665(4) alone, then, the rule removes it. As we
Cite as 357 Or 691 (2015) 713
noted earlier, it seems likely that Oregon’s UDITPA sales
factor statutes were intended to allocate individual sales:
sales of tangible personal property by where the goods are
delivered or shipped (ORS 314.665(2)) and other sales by
where the income-producing activity is mainly or entirely
performed (ORS 314.665(4)). The rule, as permissibly inter-
preted by the department, removes any doubt.
Having identified the income-producing activity, we
must next determine where the taxpayer performs it. The
first part of the inquiry involves an ostensibly simple ques-
tion: Was “the income producing activity that gave rise to
the receipts * * * performed wholly within this state”? If so,
then the analysis ends, and the receipts from that individ-
ual sale are counted as in-state sales for purposes of the
numerator of the sales factor.
If the income-producing activity is performed in
more than one state, however, the Tax Court must then
determine whether “the greater proportion of the income
producing activity is performed in this state, based on costs
of performance.” To know whether “the greater proportion”
of the activity occurs in this state, the Tax Court must neces-
sarily compare the costs of performance in different states.
As noted, the rule defines “costs of performance” as follows:
“(4)  Costs of Performance; Defined. The term ‘costs of
performance’ means direct costs determined in a manner
consistent with generally accepted accounting principles
and in accordance with accepted conditions or practices in
the trade or business of the taxpayer. For purposes of this
rule, direct costs do not include costs that are not part of
the income producing activity itself, such as accounting or
billing expenses.”
OAR 150-314.665(4) (4).
To identify the “costs of performance,” then, the Tax
Court must identify the “direct costs.” The identification of
direct costs will depend both on “generally accepted account-
ing principles” as well as “accepted conditions or practices in
the trade or business of the taxpayer.”
Expert testimony at trial indicated that the proper
identification of the “income-producing activity” would drive
714 AT&T Corp. v. Dept. of Rev.
whether costs would count as “direct costs” for the “costs
of performance” analysis. Witnesses on both sides—Allen
for AT&T, and Starkey and Michelle Henney, accounting
experts, for the department—all agreed in substance that
one must know what is being “costed” in order to iden-
tify what constitute the “direct costs” of that thing. Allen
testified:
“A direct cost is that cost which is directly attributable
or directly related to that which I’m trying to cost. So I’m
not trying to be obtuse here.”
Henney explained:
“[W]e have to specify what are we talking about before we
can find the causal relationship that is direct or indirect.”
And Starkey noted:
“[F]or purposes of a separate call, as we have talked about
earlier, a single call, those [direct] costs would be very dif-
ferent than they would be for all calls.”
E.  Application
With that legal background, we turn to the issues
presented in this case. Again, as noted, the burden of proof
is on AT&T to demonstrate its entitlement to a refund. See
ORS 305.427. As a practical matter, that means AT&T had
to introduce evidence showing that, in connection with its
sales of interstate and international voice and data trans-
mission, a greater share of the “costs of performance” for
each “income-producing activity” was incurred in a state
other than Oregon.
The parties here offered two competing interpreta-
tions of what constitutes AT&T’s income-producing activity.
AT&T’s interpretation focused on the operation of the net-
work broadly, which was part of its justification for treating
network costs as “costs of performance.” The department’s
interpretation focused on individual transactions with cus-
tomers, and that was part of its justification for concluding
that network costs should be left out of the “costs of perfor-
mance” analysis.
As we have stated, we agree with the department’s
interpretation. OAR 150-314.665(4) (2) indicates that an
Cite as 357 Or 691 (2015) 715
“income-producing activity” is something associated with
an individual “item of income.” The department interprets
“item of income” to relate to individual sales, either per-
minute charges for phone calls or flat-rate monthly subscrip-
tions (or similar data transmission sales). That interpreta-
tion is plausible and is not inconsistent with any source of
law that AT&T has identified.
That narrow definition of “item of income” corre-
spondingly affected the meaning of “income-producing
activity.” An “income-producing activity” consists of the
“transactions and activity” that the taxpayer performs
for each individual transaction—“each separate item of
income.” OAR 150-314.665(4) (2). In other words, the
“income-producing activity” consists of those transactions
and activity that produced each individual sale, i.e., each
per-minute phone call or transmission or each monthly flat-
rate bill. AT&T’s network-focused interpretation of the term
is too broad.
That alone would justify affirming the Tax Court’s
decision. For AT&T to meet its burden of proof in this case, it
had to first calculate the costs of performance for its income-
producing activities. But AT&T’s cost study did not identify
the correct income-producing activities. The cost study thus
did not show what the costs of performance were for the cor-
rect income-producing activities.
In addition, AT&T’s erroneous interpretation of
“income-producing activity” also distorted its calculation of
the “costs of performance.” The experts here agreed that a
transaction-based interpretation of “income-producing activ-
ity” would also narrow what constitute the “direct costs” for
the “costs of performance” part of the analysis. AT&T’s own
expert, Allen, acknowledged that, if the income-producing
activity here was individual phone calls, then the “direct
costs” arguably would not include network costs. After first
explaining AT&T’s position that one should determine the
“income-producing activity” at the level of the network or
system—in which case all the costs of the network would be
“direct costs”—Allen then explained that the “direct costs”
might be different if one examined the “income-producing
activity” at the level of individual calls:
716 AT&T Corp. v. Dept. of Rev.
“If * * * I’m looking at a call-by-call basis, doing a differ-
ent type of modeling, I might be able to consider something
less direct in that nature. So an example might be if I were
to determine that direct cost is based on what I’ll call this
notion of the incremental cost.
“So as an example, the network is there. It exists. If I
place a call on that network, I’m using it. However, if I don’t
place that call, that network is still there. I don’t—that cost
I have still incurred.
“So the argument might be made that, therefore, that
call, the network is not a direct cost associated with that
call. The argument I make is that’s an inappropriate level,
especially as it relates to the questions we are attempting
to answer.”
That is precisely the department’s position: The
direct costs of the income-producing activity, each individ-
ual phone call or monthly flat-rate billing, are only those
incremental costs associated with each individual call or
billing, not overall network costs. Starkey testified:
“It is an issue of—just to preface, it is an issue of the
increment that you are choosing. For one call—and kind of
think of it from a marginal versus sunk cost perspective.
If you are looking at the cost of one call and the network
is there, then, as I think I describe in the report, the cost
associated with that one call is just the additional expense
you incur to carry that one call.
“And in this circumstance, that’s likely something very
small. It is going to be the access charge you pay for pur-
poses of using someone else’s network to help carry that
call and then probably—and * * * also just the electricity
necessary to carry that particular call.”
Thus, AT&T’s cost study again failed to meet
AT&T’s burden of proof. AT&T’s network-based interpre-
tation of “income-producing activity” implied that network
costs counted as direct costs. But a transaction-based inter-
pretation of income-producing activity means that network
costs do not qualify as direct costs. AT&T’s cost study did
not identify the relevant non-network costs for each income-
producing activity. Without a correct calculation of those
direct costs, the Tax Court could not tell where the greater
part of those costs were incurred. The court certainly had
Cite as 357 Or 691 (2015) 717
no basis to find that the greater part of those costs were
incurred in some state other than Oregon.
The same problem also undermined the second part
of AT&T’s cost study, which analyzed the costs of “Oregon
demand.” As with the first part of the cost study, AT&T
counted overall network costs as part of the “direct costs” of
Oregon demand. However, the income-producing activities
are the individual transactions, and so the “direct costs” are
only those incremental costs associated with each transac-
tion. Because the second part of the cost study treated net-
work costs as “direct costs,” it failed to show what the true
“costs of performance” were, and this resulted in AT&T not
meeting its burden of proof. 15
III. CONCLUSION
To succeed on its claim for a refund, AT&T was
required to (1) show the costs of performance for each
income-producing activity, and then (2) show that the
greater part of those costs had been incurred in some state
other than Oregon. The cost study that AT&T submitted did
not identify the correct income-producing activities and it
did not correctly calculate the costs of performance for those
activities. AT&T thus failed to make the showing required
to meet its burden of proof.
Accordingly, we conclude that the Tax Court prop-
erly denied AT&T’s request for a refund. We need not, and
do not, address the other questions presented by the parties,
including whether the access charges paid to local exchange
carriers should be counted as part of the relevant income-
producing activity.
The judgment of the Tax Court is affirmed.
15
We note that, if the department’s interpretation of OAR 150-314.665(4) (2)
leads to unfair results in particular cases, then either the taxpayer or the
department may seek an alternative method of apportionment. See ORS 314.670
(UDITPA section 18; if ordinary method of apportionment under UDITPA does
not “fairly represent the extent of the taxpayer’s business activity in this state,”
then alternative method may be used); see also OAR 150-314.280-(M) (2) (for
public utilities being taxed under ORS 314.280, if ordinary methods of appor-
tionment “do not fairly and accurately reflect the net income of the business done
within Oregon,” then alternative method of apportionment may be used).