Corporate Close-Up: Colorado Latest State to Enact Market-Based Sourcing

Colorado became the latest state to adopt market-based sourcing rules for corporate income taxpayers apportioning income to the state when Colorado Gov. John Hickenlooper (D) signed H.B. 1185 into law on June 4, 2018.

H.B. 1185 is effective for tax years beginning on or after Jan. 1, 2019, and substantially follows the Multistate Tax Commission’s (MTC) model statute for market-based sourcing. It remains to be seen how closely Colorado adheres to the MTC’s model regulations.

Apportionable Income and Market-Based Sourcing

For tax years prior to 2019, Colorado defines income in terms of “business” or “nonbusiness” income. The bill eliminates those definitions for taxable years beginning in 2019 in favor of distinguishing income in terms of “apportionable” or “non-apportionable” income. This amended definition keeps Colorado in step with the MTC’s income definitions. In Colorado, apportionable income includes any income that would be allocable to Colorado under the U.S. Constitution, but that is apportioned rather than allocated, and all income that is apportionable under the U.S. Constitution that is not allocated under Colorado law. Apportionable income includes income from the acquisition, management, employment, development, or disposition of the property if the property is or was related to the operation of the taxpayer’s trade or business.

The market-based sourcing rules for sales other than tangible personal property require that income from the sales of intangibles and the sales of services be apportioned based on where the income-producing item or activity is used or delivered. Prior rules require that income to be sourced based on where the income producing activity is performed.

New Alternative Apportionment Rules

Colorado taxpayers seeking alternative apportionment may still do so, but the bill also enables the Colorado Department of Revenue to establish alternative apportionment rules “on an industry-wide, transaction-wide, or activity-wide basis.” In contrast to Colorado’s existing alternative apportionment statute, H.B. 1185 explicitly provides that a party seeking to establish alternative apportionment bears the burden of proof. However, the Department does not bear the burden if it can show that the taxpayer used an apportionment method at variance with its allocation and apportionment method or methods in any two of its previous five tax years.

Prior to 2019, Colorado taxpayers source receipts for services and other intangibles based on the cost of performance methodology. Market-based sourcing principles were only used as an alternative apportionment method when the Department determined that the statutory cost of performance methodology did not fairly represent the taxpayer’s business activities within the state.

Industry-Specific Apportionment Remains in Place for Now

Further, H.B. 1185 specifically does not override the industry-specific apportionment rules under 24 Colo. Regs. § 60-1301, though the Department will need to evaluate their continued viability. Absent additional guidance from the state, industry specific formulas should continue in effect where appropriate.

Impact of Market-Based Sourcing on Colorado Taxpayers

Colorado’s sourcing regime change will likely impact out-of-state businesses with substantial sales of intangible property and services to Colorado customers by increasing their tax obligations to the state. However, tying apportionment to a market-based methodology and utilizing a single-sales factor formula may position Colorado as a more attractive jurisdiction to establish business operations.

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: How will businesses respond to Colorado’s apportionment regime change?

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