As the U.S. economy continues to shift away from manufacturing and toward the sale of services and intangibles, states are increasingly focusing on policies on how multistate corporations must source sales receipts when apportioning income to their jurisdiction. “Sourcing” refers to the rules a state uses to determine if it will attribute certain sales receipts to its jurisdiction for purposes of imposing corporate income tax. As noted in the Bloomberg BNA Survey of State Tax Departments, a growing number of states have shifted from cost-of-performance based sourcing, in which receipts from sales other than those of tangible personal property are sourced to states where the costs of performance are incurred, to market-based sourcing, in which receipts are sourced where the benefit of the service is received. However, the states have various ways of defining where the benefit is received that create complications.
New York and Michigan have recently attempted to clarify their market-based sourcing rules for these receipts. New York has released a set of draft regulations to incorporate the changes made in the state’s corporate tax reforms over the last two years, to be implemented after public comments in 2016. Michigan has released an administrative bulletin explaining its approach to receipts from the sale of services and giving examples.
In 2014 New York State overhauled its corporate tax code, including its apportionment rules with the implementation of N.Y. State Tax Law § 210-A. For receipts from services or other receipts not specifically addressed in the statute there is a catchall provision in N.Y. State Tax Law § 210-A(10) that provides a hierarchy of methods for determining whether receipts are to be included in the numerator of the state’s apportionment factor. On October 15, the New York State Department of Taxation and Finance released draft amendments to New York State Business Corporation Franchise Tax Regulations §§ 4-4.6 (Other Business Receipts) and new 4-4.9 (Receipts from Sales of Digital Products).
Both sections of draft regulations describe the rules for applying the hierarchies for sourcing receipts found under N.Y. State Tax Law § 210-A(10) for other services and receipts and N.Y. State Tax Law § 210-A(4) for receipts from sales of digital products. When sourcing receipts that fall into these categories, taxpayers must exercise due diligence under each method in the corresponding hierarchy before they can reject it and move to the next method if it does not apply. For example, the first method in the hierarchy for other services and receipts listed under N.Y. State Tax Law § 210-A(10) is the benefit of the service is received in the state. Once a taxpayer has done its due diligence and is unable to determine if the benefit was received in New York, they may move on to using the delivery destination as the next method. A similar hierarchy exists in N.Y. State Tax Law § 210-A(4) for sales of digital products, for which the first method is that the state of the customer’s primary use location of the digital product is the state to which the receipt is sourced.
Both draft regulations go through each step in the hierarchy, explaining how the terms are defined, and providing examples for each method in the hierarchy as they will be applied. One example of where the benefit is received is described as:
Travel Support Corp, located in New York State, provides travel information services to its customers, who are individuals located throughout the United States, through a call center located in New York State. The contract between Travel Support Corp and its customers provides that for a fee per call, the customer can call Travel Support Corp for information regarding hotels, restaurants and other travel related information. Travel Support Corp's books and records maintained in the regular course of business indicate that 15 percent of its customers have billing addresses in New York State. However, Travel Support Corp's books and records indicate that only 7 percent of the calls handled by the call center originate from New York State. Because Travel Support Corp's books and records show where the benefit of the services is actually received based on the origination location of the calls, Travel Support Corp may overcome the billing address presumption by using its books and records to source to New York State 7 percent of its receipts from the support services provided by the call center.
Michigan also recently released Revenue Administrative Bulletin 2015-20, which aims to clarify when receipts from sales from services should be sourced to the state. Like New York, Michigan has instituted a market-based sourcing system that is based on whether the recipient of the services has received the benefit of the services within the state. The bulletin explains:
Sourcing of receipts will continue to be an issue as more states move to market-based sourcing for receipts from sales of other than tangible personal property. New York is accepting comments from the public on the draft regulations until Jan. 16, 2016. As rules change, states will continue to put out more guidance that will hopefully clarify the new statutory schemes.
The New York draft regulations can be viewed here:
Michigan Revenue Advisory Bulletin 2015-20 can be viewed here:
Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: Should states move to market-based sourcing for receipts from sales other than of tangible personal property?
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