"Vodafone Variance The Commissioner's Power to Override the Rules" by J Leigh Griffith Tennessee CPA Journal 

May, 2016 - J. Leigh Griffith

Vodafone Variance: The Commissioner's Power to Override the Rules

Following the Tennessee Court of Appeals decision in Vodafone Americas Holdings, Inc. and Subsidiaries1 ("Vodafone AH") dealing with the Commissioner's power to issue a variance in the allocation and apportionment rules for multistate businesses (whether corporate, LLC, LP or any other entity subject to the Tennessee franchise and excise tax), the author wrote a column entitled "The Variance Wildcard to Tennessee Apportionment-Vodafone" for the Tennessee CPA Journal.2 In Vodafone AH, the Court of Appeals upheld the Commissioner's authority to impose a variance on Vodafone Americas Holdings, Inc. ("Vodafone"). At the time it appeared unlikely Vodafone would appeal the case, but they ultimately did. This decision was undoubtedly heavily influenced by the rationale and analysis of the dissenting opinion written by Judge Frank G. Clement Jr.3 While Judge Clement held his nose4 when deciding that the Commissioner had exceeded the Commissioner's statutory authority, he felt the exercise of the variance represented a change in tax policy that was the prerogative of the legislature, not the courts.

The Tennessee Supreme Court heard the case in June 2015, and on March 23, 2016, it rendered its opinion upholding the variance and finding in favor of the Commissioner.5 The application of the statutorily required cost of performance ("COP") method of apportionment that the variance overruled necessarily results in an all-or-nothing apportionment in the Tennessee sales factor and is inherent in the use of the formula. The taxpayer's situation was not unusual or unique, except for the amount of money involved. Unfortunately, the Tennessee Supreme Court has now substantively determined that neither the "unusual" requirement nor the parenthetical "(which ordinarily will be unique and nonrecurring)" are actually requirements, since in this case the failure to "fairly represent the extent of the taxpayer's business activity in this state" seems to satisfy both the statute and the regulations' constraints. Perhaps equally unfortunate from a state tax policy perspective is the Multistate Tax Commission ("MTC"), whose purpose is to foster uniform multistate tax laws, reaching the same conclusion in its amicus brief, which bodes poorly for the uniformity of state tax law across the country and the stated mission of the MTC.

The Constitutional issue as to whether there was a violation of the separation of powers was not considered as a result of procedural rules. Although the argument had been made from day one that the Commissioner's variance was contrary to the policy choice made by the General Assembly, it was apparently not made within a Constitutional argument. The Commissioner imposed a variance on the taxpayer in circumstances in which the application of the franchise and excise tax apportionment statutes reached the precise result the legislature intended when adopting the statute. Yet the Commissioner, through a variance, has changed the law applicable to a taxpayer. The Tennessee Supreme Court determined that Vodafone had waived that issue by not raising it in the trial court, and therefore the Court would not consider it.

The variance power, when initiated and exercised by the Commissioner, essentially says the specific taxpayer is following the statutory and/or regulatory rules, but the result, in the opinion of the Commissioner, does not fairly represent the extent of the taxpayer's business activities in the state. Therefore, the Commissioner issues a variance imposing another method the Commissioner believes is appropriate, which increases the Tennessee tax. The taxpayer, after the business activity has occurred and, so far in the cases, after its tax return for the year was filed, is told their result is "too good" to be true and that they must use a method different from that required or permitted by the statute and regulations, and pay more tax.6 The use of the variance power by the Commissioner can discriminate against specific taxpayers and destabilize multistate tax law, and unless it is isolated to truly unique circumstances, the Commissioner's use of variance power harms multistate uniformity. In Vodafone AH, the Commissioner determined that the inevitable result of applying the required COP method by a large taxpayer did not clearly reflect the business activity of the taxpayer in Tennessee, so a different method was imposed.

The Tennessee Court of Appeals in BellSouth Advertising & Publishing Corp. v. Chumley7 ("BAPCO"), and now the Tennessee Supreme Court in Vodafone AH, have determined that the variance power overrode the policy decision of the General Assembly to adopt an all-or-nothing approach through the use of the COP. In these large-dollar cases, the Supreme Court determined the Commissioner can override the statutorily required method of apportioning receipts even when the results are foreseeable: some taxpayers who do extensive business in Tennessee will source no receipts to Tennessee and some with extensive business outside of Tennessee will source all receipts to Tennessee. At least in BAPCO, there was the argument that a unique situation arose because the payment for the advertising (services that were performed in another state) did not arise until the yellow page books containing the advertising were delivered in Tennessee. Therefore, there was an unusual fact situation and a unique Tennessee event that would not reoccur in the industry. While COP has been put to rest by the new Revenue Modernization Act8, which sources receipts based on location of user (the standard the variances imposed in both cases), the scope of the Commissioner's power is broad and unclear.

Anti-abuse powers are needed by a Commissioner for the administration of sound tax policy. However, should results that are foreseeable and inherent in the tax policy choice made by the General Assembly be subject to override by the Commissioner? In the future, can the Commissioner determine that market-based sourcing does not clearly represent the extent of the taxpayer's business in Tennessee by a large Tennessee service provider performing all of its services in Tennessee with tens or hundreds of millions of dollars of sales to customers outside of Tennessee? Does it make a difference if customers are in a state that uses COP for its sourcing of receipts so that these tens of millions of sales represent "nowhere income"? What other prescribed rules applying to an industry can be overridden by the Commissioner on a taxpayer-by-taxpayer basis?

The variance power and its use with respect to a taxpayer after the events have occurred is perhaps the nuclear option in the Commissioner's arsenal with respect to multistate taxation and perceived abuses. As such, it should be used sparingly. However, based on Vodafone AH, the variance power can apparently override a statutory scheme in which the objected result is foreseeable or even foreseen9, may be influenced by tax policy decisions made by other states adopting different sourcing and apportionment rules than Tennessee, and may even be applied to one taxpayer in an industry and not another similarly situated.10

During the years at issue, Vodafone owned a 45 percent partnership interest in Cellco Partnership, a Delaware company doing business throughout the United States as Verizon Wireless. Verizon provides wireless communications and data service to its customers nationwide, including in Tennessee. Under applicable Tennessee law, the proportionate income of a general partnership flows to its partners.11

The facts are unsympathetic, as the taxpayer is a multibillion-dollar enterprise providing call and data services to customers across the country. Vodafone had been filing franchise and excise tax returns in Tennessee, apportioning its sales using the primary-place-of-use method ("PPU"). Under that method, Vodafone reported $1.3 billion of sales attributable to Tennessee. This method, however, was applicable to sales of tangible personal property but not services for the periods covered by this case. At some point, Vodafone changed tax counsel and decided it had been filing returns and paying taxes in a number of states in which, in counsel's opinion, it was not required to do so. Claims for refunds that were apparently based on an argument that there was no nexus were filed and denied. It appears the rationale as to why Vodafone was entitled to a refund "evolved" over the course of the litigation. The rationale ultimately included Tennessee's sourcing law, which required receipts from the sale of services or intangibles to be based on COP, not PPU. The result, as computed by the taxpayer, was the reduction of receipts sourced to Tennessee by 89 percent, from $1.35 billion to $151 million. The Commissioner believed the computation was faulty, and the accuracy of the calculations was reserved for future resolution in case the variance power was not upheld. The Courts, however, appeared fixated on the numbers.

The Commissioner's arguments were:

  1. Vodafone had extensive sales in Tennessee and reported $1.35 billion of receipts under the PPU formula. The COP formula only produced $151 million of receipts, which is not a fair representation of Vodafone's business activity in Tennessee.12

  2. Vodafone claimed it had higher costs of performance in California, Georgia and New Jersey, but none of those states use the COP methodology, and therefore millions of dollars of Vodafone's earnings from Tennessee residents escaped their "fair share" of taxation in Tennessee.

  3. The application of the COP to Vodafone's intangible sales activity is very difficult to audit.

  4. Such a situation is unusual.

  5. The Commissioner's imposed PPU method is reasonable.


Fair representation of taxpayer's business in the state. The Supreme Court found that the results of the statutorily required COP did not fairly represent the taxpayer's business activity in the state. While this visceral response is understandable, the Court did not address the fact that the all-or-nothing approach of the COP would never fairly reflect the extent of said business activity if the taxpayer had significant activity outside Tennessee. It would always be understated or overstated. That is inherent in the COP, as it finds where the "greater proportion" of the activity occurs. When the methodology required by the General Assembly fails to include substantial receipts from Tennessee customers, in the absence of unusual and unique facts (which in the author's opinion but obviously not that of the Commissioner or the Supreme Court, did not exist in Vodafone AH), the results are the results, and by definition they reflect the business activity in the state.

Unusual Fact Situation. Although not required by statute, regulation 1320- 6-1-.35 only permits the issuance of a variance in specific cases in unusual fact situations (which ordinarily will be unique and nonrecurring) producing incongruous results. The regulations were based on model rules and were presumably designed to meet Constitutional requirements.

The Supreme Court appears to be heavily influenced by Benjamin F. Miller's testimony as an expert witness for the Department of Revenue. Miller stated there were two principles behind UDITPA: 1) to obtain uniformity in state rules of allocation and apportionment so that income would not be assigned to more than one state, and 2) so that > no income should escape taxation. The Supreme Court seemed fixated over "nowhere income" and the UDITPA goal of taxing 100 percent of the taxpayer's income, saying, "Here, application of the statutory apportionment formula causes millions of dollars in receipts from Vodafone's Tennessee customers to vanish, for tax purposes. This qualifies as an 'unusual fact situation.'"13 In short, the all-or-nothing approach of the statute produced a large nothing, and the Supreme Court determined such nothing satisfies the "unusual" standard. Because of the term "ordinarily" in the parenthetical "(ordinarily unique and nonrecurring)," the Supreme Court did not consider unique to be an absolute requirement.14

The Supreme Court also felt the multistate telecommunications industry was not envisioned by the draftsmen of UDITPA, feeding into the "unusual" rationale. The concept of the application of tax law and regulations only applying to industries in existence when adopted, which may be varied by the Commissioner later in the absence of legislation, is a dangerous tax policy. Accordingly, the Commissioner does not have the power to effectuate an industry-wide variance but only to issue variances in a discriminatory manner within an industry. So the Supreme Court shifted the burden of proof to the taxpayer, whereas pre-existing precedent required the proponent of the variance to carry the burden of proof.15

It does not seem unusual for a taxpayer doing business in many states to have millions of dollars of income from Tennessee customers that would not be Tennessee receipts under COP. There are a large number of states16 that do not use UDITPA rules, and therefore it is not unusual to have "nowhere income" or "income in two places." When a statute requires specific analysis, audit difficulty in implementing should not be a basis for a variance, but instead a basis for a law change.

PPU method is reasonable. The Supreme Court determined that the PPU formula was reasonable, and the Commissioner properly exercised his variance powers.

Timing of Variance. If a request is made by the taxpayer for a variance, the taxpayer is required to make the request before the tax return is filed.17 This is a reasonable requirement, and a case could be made that it should be a requirement for the Commissioner as well. In cases where the taxpayer has used the method required by statute, and the Commissioner desires to impose a variance, the author believes the variance should be prospective. The Supreme Court, however, gave no dicta on this aspect.

Dismissal of dissenting opinion. The brief note at the end of the majority opinion regarding the partial dissent by Judge Bivins18 seems to demonstrate a lack of understanding or simple disregard of the dissent. The majority opinion articulates that the key to the dissent is the word "unique." The primary basis for the dissent is (i) the burden of proof is on the party seeking the variance and (ii) there is no proof that the situation is unusual and therefore the regulatory requirements for imposing the variance were not met. Judge Bivins would impose on the Commissioner the burden of proof to demonstrate that this was not an industry-wide practice and hence unusual. While the dissent provides the "ordinarily unique" requirement as an additional basis of the Commissioner's failure of proof,19 it is not the only or primary basis of the dissent.

Conclusion. The variance authority continues to exist and is applicable to the Revenue Modernization Act. Therefore, the standards for its application need to be clear and fair to both Tennessee and taxpayers filing returns consistent with statutory provisions. The General Assembly is attempting to make Tennessee an attractive location for business and job growth. Taxation by rule of law with a minimum of surprises should be a part of that effort. There should be an underlying fairness to the application of tax law.

It seems fair that if an issue is likely an industry issue, the Commissioner should either (i) have a variance power for the industry on a prospective basis and enforce the variance across the industry, so that similarly situated taxpayers are treated the same20, or (ii) be forced to go to the General Assembly to change the law. If the audit difficulty of determining if the COP incurred in another state is greater than the COP in Tennessee makes the Department of Revenue unable to verify the taxpayer's representations regarding where most costs are incurred, the department needs additional funding to implement the Revenue Modernization Act provisions for determining where the ultimate customers are located when the sale of goods or services is to a party that resells such goods or services. This inquiry requires much more precision and will be a common occurrence across virtually all industries.

The Vodafone case raises a concern that the variance power and the rationale for its application may have expanded in a dangerous manner. First, the requirement that the fact situation must be "unusual" seemed to have been glossed over by the assertion that failure to properly reflect the extent of the taxpayer's economic activity in Tennessee solves the "unusual" requirement. The "unusual" requirement is at least in part a restriction to prevent selective or discriminatory application of the tax law among taxpayers, with underpinnings of compliance with equal protection of the law. Second, the parenthetical "(which ordinarily will be unique and nonrecurring)" is basically read out of the regulation, and it is also a restriction to prevent selective application of the tax law.

Third, the Court's (and Commissioner's) fixation with "nowhere income" as a result of Tennessee and other states having differing apportionment laws is questionable. The rationale that the goal of UDITPA is to tax all income once is premised on all states adopting UDITPA. But there is no provision in UDITPA that calls for the taxation of income that other states choose not to tax that would be taxed if such states adopted UDITPA. It is questionable, and perhaps even inappropriate, for Tennessee to consider whether another state with the power to tax under Tennessee's methodology has chosen not to exercise that power as an indication that a result does not reflect the extent of the taxpayer's economic activity in Tennessee. When the result is foreseeable and dictated by a policy decision of the General Assembly, there is a separation of powers issue.

Finally, there are potential "equal protection under the law" concerns when the Commissioner can require one taxpayer to be taxed in a manner that does not apply to all similarly situated taxpayers. Vodafone had bad facts, and as a result bad law has developed. Unless or until the General Assembly modifies the law, taxpayers and practitioners will have to live with it.


1Vodafone Ams. Holdings, Inc. v. Roberts, No. M2013-00947-COA-R3-CV, 2014 Tenn. App. LEXIS 362 (Tenn. Ct. App. June 23, 2014).

2J. Leigh Griffith, "The Variance Wildcard to Tennessee Apportionment -Vodafone," Tennessee CPA Journal, Sept.-Oct. 2014, at 30, available at http://bit.ly/1QNUUxB.

3In the interest of full disclosure, the author currently has a case in which the Commissioner has attempted to exercise his variance power on an issue that has involved a large number of taxpayers for a number of years. Whether the variance power in this matter has been exercised with respect to other taxpayers is presently unknown.

4"[I]t is readily apparent from the Commissioner's variance letter that he did not favor the result that flowed from applying the statutorily-mandated cost of performance methodology; admittedly, neither do I." Vodafone Ams. Holdings, 2014 Tenn. App. LEXIS 362, at *75.

5Vodafone Ams. Holdings, Inc. v. Roberts, No. M2013-00947-SC-R11-CV, 2016 Tenn. LEXIS 182 (Tenn. Mar. 23, 2016).

6"Beauty" as well as "too good to be true" is in the eye of the beholder. In both Vodafone AH (see supra notes 1 and 5) and BAPCO (see infra note 7) the results advocated by the taxpayer may be such that most would consider to be "too good to be true" but the Commissioner's view of other factual situations in which the Commissioner determines to exercise the power may be more "run of the mill" situations. Great discretion in the exercise of this power is urged as it is a very slippery slope that winds up in a banana republic.

7BellSouth Adver. & Publ. Corp. v. Chumley, 308 S.W.3d 350 (Tenn. Ct. App. 2009). McDermott Will and Emory ranked this the worst case of 2009. Its award introduction began "[i]t would be difficult–if not impossible–to find a court decision that says 'the statute does not matter, we want revenue' more clearly . . . ." McDermott Will and Emory, State Tax Developments: The Best and Worst of 2009 2 (2010), http:// bit.ly/1SV98Bh.

8For a discussion on the Revenue Modernization Act, see J. Leigh Griffith, "Tennessee's Pending 'Revenue Modernization Act,'" Tennessee CPA Journal, Mar.-Apr. 2015 at 14, available at http://bit.ly/1TGeKPQ.

9Subject to future Constitutional arguments that were not heard by the courts.

10Section 18 of the Uniform Division of Income for Tax Purposes Act provides for an industry variance. Tennessee's statute and regulations do not.

11TENN. CODE ANN. § 67-4-2012(g).

12Note: the actual calculations were reserved for a future fuss if the variance was rejected. However, the Tennessee Supreme Court and the other courts were clearly influenced by the magnitude of the amount it thought was escaping taxation. It is possible that the actual numbers would be significantly different.

13Vodafone Ams. Holdings, Inc. v. Roberts, No. M2013-00947-SC-R11-CV, 2016 Tenn. LEXIS 182, at *89-90 (Tenn. Mar. 23, 2016).

14Although the Tennessee Supreme Court seems to be enamored with Miller and includes several quotes from him, the Court seems to have missed an important use of the word "unique" in one of his quotes:

"One of the problems which I think Section 18 addresses is the fact that you see these things sometimes the first time in filing a return or through a claim for refund, . . . and it's only then that you become aware that you have an issue . . . that may be unique to the taxpayer."

Id. at *28. This would imply that Mr. Miller gives credence to "unique."

15Am. Tel. & Tel. Co. v. Huddleston, 880 S.W.2d 682, 691 (Tenn. Ct. App. 1994). This was pointed out in the dissent but the majority found the case inapplicable because it dealt with a different application of the same variance rule. Vodafone Ams. Holdings, Inc., 2016 Tenn. LEXIS 182, at *99-101 n.47.

16The MTC amicus brief apparently states that more than 30 states have adopted all or part of UDITPA. That leaves 20 percent to 40 percent that have not adopted all or part of UDITPA. There are bound to be many conflicts between the methodology used by Tennessee and those used by such other states such that it would not be unusual to have large amounts of "nowhere income."

17TENN. COMP. R. & REGS. 1320-6-1- .35(1)(c). Application for relief must be addressed to the Commissioner of Revenue with the filing of a petition, in writing, setting forth the reasons why application of the statutory allocation and apportionment provisions do not fairly represent the extent of the taxpayer's business activity in this state. It must be shown by clear and cogent evidence that peculiar or unusual circumstances exist which would cause application of the said statutory provisions to work a hardship or injustice. Such application must also include a proposed alternative method of allocation or apportionment to be used by the corporation, and be submitted by the taxpayer on or before the statutory due date of the return. In the event that a variation from the statutory provisions is adopted, then such method shall continue in effect so long as the circumstances justifying the variation remain substantially unchanged. It shall be the duty of the taxpayer to furnish each subsequent year such information with the filing of its return as will establish the fact that the circumstances remain substantially unchanged. Id.

18Id. at *99-100.

19Vodafone Ams. Holdings, Inc., 2016 Tenn. LEXIS 182, at *108-10 (Bivins, J., dissenting).

20This will require a statutory change.



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