4/16/2015
Surviving Market-Based Sourcing:
The New Frontier with No Rules
2015 Spring Audit Session/Income Tax Conference
Memphis, TN / April 22, 2015
John Paek
Baker & McKenzie LLP
[email protected]
(650) 856-5548
Harley Duncan
KPMG LLP
[email protected]
(202) 533-3254
Council On State Taxation
Agenda
• Background
• Trend Toward Market-Based Sourcing and Single-Sales
Weighting
• What do We Mean by “Market”?
• MTC Revisions to UDITPA
• Market-Based Sourcing Without Legislation
• Sourcing Scenarios
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Learning Outcomes
• Gain a general understanding of sourcing issues for state
income tax purposes
• Introduction to the movement towards market-based sourcing
and single-sales weighting
• Learn how market-based sourcing can be applied under
different state rules and in different scenarios
Polling Question
• Generally speaking, market-based sourcing refers to?
A. The agricultural methods of farm-to-table restaurants
B. The real-estate surrounding the New York Stock
Exchange
C. A destination-based method for assigning sales to
states
D. All of the above
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Background
• There is a constitutional requirement for fair apportionment in
multistate income taxation. See Moorman Mfg. Co. v. Bair, 437 US
267 (1978)
• Broadly, apportionment is fair when it accurately reflects the
taxpayer’s in-state activities
• Historically, states have used three factors to measure the
taxpayer’s in-state activities: property, payroll, and sales
• Over time, states have placed greater emphasis on the sales factor
as a way of reducing the burden of the corporate tax on those with
in-state property and payroll
• In today’s digital economy, states are placing a greater emphasis on
the sales factor and developing new ways to source the sales
Background
• States have adopted a variety of different methods for sourcing
sales of things other than TPP
– Greater Cost of Performance (COP)
» All‐or‐nothing approach
» Focuses on where the item/service was mostly produced
– Proportionate COP/Relative Value
» Proportionate cost approach
» Splits sourcing among different places of production
– Market‐Based Method
» Non-cost based
» Destination-based
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Trend Towards Market-Based Sourcing
• Many states are moving towards market-based sourcing,
particularly for sales of services and intangibles
– Reasons
» Difficulty in determining where the costs of production for a
service or intangible are located
» Attempt to match receipts to the source of the
corresponding revenue stream
» Requests from in-state businesses, which may have high
property/payroll factors in the state, but relatively few sales
in the state
Single-Sales Factor Apportionment
Mandatory Single-Sales Factor for General Corporate Income Tax Purposes
2000
Connecticut
Illinois
Iowa
Mississippi
Nebraska
Texas
2008
2015
Connecticut
Georgia
Illinois
Iowa
Maine
Michigan
Nebraska
New York
Oregon
Texas
Wisconsin
California
Colorado
Connecticut
District of Columbia
Georgia
Illinois
Indiana
Iowa
Maine
Michigan
Minnesota
Nebraska
New Jersey
New York
New York City (phasing in)
Oregon
Pennsylvania
Rhode Island
South Carolina
Texas
Wisconsin
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Sales Factor Weighting and Market-Based Sourcing
Percentage of States Using
IPA/COP (or service performed) vs. MBS
100%
2
90%
80%
9
70%
18
60%
50%
8
40%
30%
7
20%
3
10%
0%
Three Factor
Double Weighted
Sales Factor Weighting
IPA/COP
Single Sales
MBS
Sourcing for Other than Sales of TPP (2015)
MA (2014)
2015
RI (2015)
2014
2014
2013
2014
DC (2015)
No Income Tax Imposed
IPA/COP (AK, DC, HI)
Pro Rata % COP (CO, CT, DE, LA, NJ, NY, NC, SC, TX)
Market, with open IPA/COP years
Market
Factor Presence Economic Nexus
AZ – Effective for 2014, an
election is available to
phase-in market sourcing for
multistate service providers.
Otherwise, IPA/COP
sourcing applies.
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What do We Mean by “Market”?
Market-Based
Sourcing
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•
•
•
•
•
•
Benefit Received
Arizona (election)
California
Iowa
Michigan
Ohio (CAT)
Rhode Island
Utah
Wisconsin
•
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•
Service Received
Illinois
Maine
Minnesota
MarketBasedSourcing
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•
•
•
•
Service Delivered
Alabama
District of Columbia
Massachusetts
Pennsylvania
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•
•
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•
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Customer Located
Georgia
Maryland
Nebraska
New York
Oklahoma
Income Producing
Activity/ Cost of
Performance
Service Performed
•
•
•
•
•
•
Colorado
Connecticut
Delaware
Louisiana
New Jersey
Texas (Franchise tax)
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Alaska
Arkansas
Florida
Hawaii
Idaho
Indiana (Benefit)
Kansas
Kentucky (Delivered)
Mississipi (Benefit)
Missouri (Benefit)
Montana
New Hampshire
New Mexico
(Delivered)
North Carolina
North Dakota
Oregon
South Carolina
Tennessee
(Delivered)
Vermont
Virginia
West Virginia
Common Construction of a Sourcing Statute/Regulation
•
•
•
•
•
Primary statutory rule
– Benefit received, service received, service delivered, etc.
Administrative regulation
– Distinction among types of services
» In-person
» Delivered electronically
» Business service
Default locations
– Location of ordering office
– Billing address
Reasonable approximation
Thowout?
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Market-Based “Look Through” Sourcing
Licensee /
Retailer in
“market”
state
Licensor of
intangible (i.e.
trademark) in
COP state
No Income Tax Imposed
IPA/COP (AK, DC, HI)
Pro Rata % COP (CO, CT, DE, LA, NJ, NY, NC, SC, TX)
Market, with open IPA/COP years
End Consumer
in “look
through” state
Market
Polling Question
• Generally speaking, who benefits from market-based
sourcing?
A. No one
B. The state due to administrative ease
C. In-state taxpayers that have a lot of in-state property
and/or payroll, but relatively few in-state sales
D. Both B and C
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Sales Factor—Alternative Sourcing Rules for Sales of
Intangibles
• Alternative sourcing rules may include, for example, sourcing
to the state where:
–
–
–
–
The intangibles have a taxable situs
The intangibles are managed or controlled
The intangibles are used by the purchaser
The taxpayer has property and/or payroll based on the property
and payroll factors for that state
– Need to be cognizant of the exact type of intangible (e.g.,
patents, trademarks, etc.) that falls under state’s special sourcing
rule
Sales Factor—Sourcing Rules for Receipts from
Intangibles Licensing
• Massachusetts
– Receipts sourced to state where intangible property used by
licensee
• New Jersey
– Receipts sourced based upon the use of the trademarks in New
Jersey in relation to all use by the licensee
• Pennsylvania
– Receipts sourced to the extent that the property is used in
Pennsylvania, or sourced entirely to Pennsylvania if the
taxpayer’s commercial domicile is in Pennsylvania and the
taxpayer is not organized under the laws of—or taxable—in the
state in which the property is used
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MTC Revisions to UDITPA Section 9
• Prior provision:
– Equally weighted, three factor apportionment formula
comprised of a payroll, property, and sales factor.
• Amended provision:
– The member state’s apportionment formula.
• Commission recommendation:
– The Commission recommends that member states adopt a
three-factor, double-weighted sales factor apportionment
formula.
• Proposal reflects the departure by a substantial number of
states from the equally-weighted three-factor apportionment
formula in favor of a single sales factor or double weighted
sales factor formula.
MTC Revisions to UDITPA Section 17
• Prior provision:
– Receipts from sales other than sales of tangible personal property
are sourced to the state in which the greater proportion of the
income producing activity occurs, based on costs of performance
• Amended provision:
– The costs of performance sourcing rule will be replaced with a
market-based sourcing rule
» Receipts are sourced to the state in which the taxpayer’s market is
located
» For services, this will generally be the state in which the service is
delivered
» For income producing property, this will generally be the state in
which the property is located or used
» If the taxpayer’s market state cannot be determined, the statute
permits a “reasonable approximation” of the taxpayer’s market
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Polling Question
• Generally speaking, for a novel market-based sourcing issue,
what may be an advisable position?
A. A reasonable approximation of the source
B. The method that best addresses the state’s budget
deficit
C. Seek guidance from your market research team
D. None of the above
Market-Based Sourcing Without Legislation
Through Focus on IPA
Through UDITPA Section 18
•
•
•
•
Vodafone Americas Holdings, Inc. v.
Roberts, No. M2013-00947-COA-R3-CV
(Tenn. Ct. App. 2014)
Equifax, Inc. v. Dep’t of Revenue (Miss.
2013), cert.denied (U.S. 2014)
Letter of Findings 02-20110473 (Ind.
Dept. of Rev. 2013)
Bellsouth Advertising & Publishing Corp.
v. Chumley (Tenn. App. 2009)
•
•
•
•
•
•
Letter of Findings 02-20140455 (Ind.
Dept. of Rev. 2015)
Cable One v. Idaho State Tax
Commission (Id. 2014)
Dish DBS corp. f/k/a Echostar DBS corp.
v. South Carolina Department of Revenue
(S.C. Admin. Law Ct. 2/10/13)
Initial Hearing No. 09-0578 (Utah Tax
Comm. 8/11/11)
AT&T v. Dep’t of Revenue (Or. Tax Ct.
6/28/11)
Florida Technical Assistance Advisement
No. 97(C)1-007 (11/7/1997)
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Services vs. “Other Business Receipts”
• In Expedia, Inc., DTA No. 825025 (Feb. 5, 2015), the New York
administrative law judge determined that, for sourcing purposes,
receipts from Expedia’s travel reservation facilitation business were
receipts from services and not, as the Department argued in the
case, “other business receipts.”
• Contrary to the Department’s position, the Expedia court found that
the N.Y. Tax Law “does not require human involvement at the
moment of sale in order for services to be performed.”
• This distinction was important for the taxpayer because New York
sourced receipts from services under a proportionate COP method;
whereas “other business receipts” were sourced to New York under
a market-based approach.
Sourcing Scenario
•
Company provides online and offline training to single customer; customer
with HQ in PA, contract negotiated in NY, invoices sent to PA. Employees
being trained in in-person setting at customer offices in PA, NY, CA, and
MA.
•
All training materials developed at Company HQ in Oklahoma. Web-based
training (live and pre-recorded) developed and delivered from Oklahoma.
•
Company also provides offline training that customer’s employees may
download or access from any location. Some of these employees will be in
states where Company does not have nexus, and Company may not know
where the employee is located when the training is done.
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Pennsylvania—Scenario (Training Services)
Online & Offline Training
In-person Training
• Where services are delivered; 72 P.S. §
7401(3)2.(A)(16.1)(C)
– “Delivery” is not defined by statute.
Per Information Notice 2014-01,
“delivery” means the location the
services are used
– Information Notice 2014-01 defines
Personal and Professional Services
to include training conducted firsthand or on a one-to-many basis,
even if the training is provided from a
remote location or delivered
electronically. If the service is
delivered in Pennsylvania, the
receipts would be sourced to
Pennsylvania, or allocated to
Pennsylvania based on the relative
value
•
•
Where services are delivered
(even if delivered by electronic
means)
Based on the Dechert and
Graham Packaging sales and use
tax decisions, an argument may
exist for treating offline training as
a sale of TPP
California—Scenario (Training Services)
In-person Training
•
Where benefit of service is
received; CCR 25136-2(c)
– Must evaluate the contract
terms or books and records
maintained in the ordinary
course of business to identify
location where benefit received
– Benefit likely received at
customer’s office locations in
CA, MA, PA, IL, and NY
Online & Offline Training
•
Where benefit of service is
received; CCR 25136-2(c)
(1) Examine contract or
books/records for location of
participants (billing address
excluded)
(2) Identify a consistently applied
reasonable approximation
methodology
(3) Location order placed
(4) Billing address
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New York—Scenario (Training Services)
Online & Offline Training
In-person Training
•
•
Catch-all (residual) service receipt
provision applies
Sourcing hierarchy (NYS Tax Law
210-A.10)
– Where the benefit of the training
service is received
– Note: New York offers no
guidance on how to determine
where the benefit is received for
catch-all services
•
•
Likely a digital product
– Includes an audiovisual work or
an information or entertainment
service, by whatever means
delivered
Sourcing hierarchy (NYS Tax Law
210-A.4)
(1) Customer’s primary use
location; or
(2) Location received by (or
designated to be received by)
the customer
Massachusetts—Scenario (Training Services)
In-person Training
Online & Offline Training
•These are in-person services provided
by the taxpayer, sourced to a state if,
and “to the extent,” the service was
delivered in that state; M.G.L. C. 63, §
38(f)
•ONLINE: Services delivered to or on
behalf of customer, sourced to “the location
at which the service is directly used by the
employees … of the customer.” 830 CMR
63.381(9)(d)4.c.ii.(b)2.a
•In-person services that are “performed
in the physical presence of the
customer” are considered received in
Massachusetts (830 CMR
63.381(9)(d)4.b.ii.(a))
•OFFLINE: Arguably an intangible that
resembles the sale of a service (830 CMR
63.381(9)(d)5. e.), sourced in same way as
online training (throwout applies): by
employee location; if unknown, use
reasonable approximation
•If can’t reasonably approximate, safe
harbor; If don’t qualify for safe harbor, then
where contract managed, order placed, or
billing address, in that order
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Questions?
John Paek
Baker & McKenzie LLP
[email protected]
(650) 856-5548
Harley Duncan
KPMG LLP
[email protected]
(202) 533-3254
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