Florida recently issued an unusual ruling that:
- Gross receipts from hedging transactions must be excluded from the sales factor, although
- Net receipts from output hedges are included, and
- Net receipts from input hedges and proprietary trading are excluded.
The rule seems to be that all hedging receipts are excluded, unless the hedging activities are connected to making a profit, like the output hedges, in which case the net receipts are included. This is definitely an odd result.
In this case, the taxpayer generates electricity using certain commodities, primarily natural gas and oil. The taxpayer uses financially-settled derivatives – such as swaps, options and futures – to hedge its risks both for the commodities it purchases (“input hedges”) and the electricity it sells (“output hedges”). The taxpayer also has a small number of “proprietary trades” in which it makes small market trades to acquire market intelligence about the spot price of electricity.
The Technical Assistance Advisement (TAA) ruled as follows:
- Gross receipts from all hedging are excluded. The TAA relies on Florida case law involving intercompany transactions to rule that “the sales factor cannot be artificially increased by the inclusion or exclusion of transactions that are not true sales . . . [and] Taxpayer’s hedging transactions are not ‘sales’ and do not represent or reflect the [taxpayer’s] business.” The TAA says it does not need to use alternative apportionment to get there.
- Net receipts from input hedges are excluded. The input hedges are like insurance – they secure a supply of raw materials and protect against price fluctuations – so the net receipts are therefore excluded from the factor because they have no profit motive and are therefore not “sales.”
- Net receipts from output hedges are included. The output hedges are “part of the actual sales of electricity” and thus profit motivated. The TAA acknowledges, but does not clearly reconcile, the logical conflict between including the net receipts as “sales” while excluding the gross receipts as not “true sales.”
- Net receipts from proprietary trading are excluded, because they are used by the taxpayer in a market research function and are therefore not profit-motivated.