Corporate Close-Up: Oregon Joins Montana in the Trend towards Market-Based Sourcing


An emerging trend in 2017 is the move of states to market-based sourcing from the cost-of-performance method. In May, Montana enacted H.B. 511 (effective Jan. 1, 2018), implementing the new version of the Multistate Tax Compact to make this switch. Oregon joined along, enacting S.B. 28 on July 3, effective for tax years beginning on or after Jan. 1, 2018.

The move by Montana and Oregon follows on the heels of the Multistate Tax Commission (MTC), which amended the Uniform Division of Income for Tax Purposes Act (UDITPA), the model act for apportionment of multistate income, in February. The amendment recognizes movement among the states and changes the rules from cost-of-performance to market-based sourcing for sales that are not of tangible personal property.

Market-based sourcing has become an attractive opportunity to states seeking to raise tax revenue from transactions by businesses operating across state lines and at a distance from their customers. Whereas the traditional cost-of-performance method is based on where the business incurs the cost of providing the service, market-based sourcing allows states to include in the apportionment formula receipts from sales that are not sales of tangible personal property based on the location of the customer. This allows states to increase the apportionment fraction for businesses that sell services or license intangible property within their borders, but have not incurred the costs within their borders. Oregon has joined Montana as the latest states to change their rules to capture these sales.

Oregon and Montana, both member states of the MTC, join more than 20 other states that have changed their sourcing rules, making their change to market-based sourcing a potential tipping point for other states.

Vincent Kalafat, a partner with Crowley Fleck PLLP in Montana, noted, “Now that the Multistate Tax Commission has amended UDITPA to adopt the market-based sourcing regime and has adopted companion regulations, I expect that other states will analyze the fiscal impacts of the market-based sourcing regime, and we may likely see a continuing trend of other states moving to market-based sourcing for services and intangibles.”

Moreover, the trend may be self-reinforcing, as states worry about losing out on revenue or causing problems for businesses based within their borders. “I believe the trend toward market-based sourcing will continue,” explains Robert Manicke, a partner with Stoel Rives LLP in Oregon. “At this point, a shift to market-based sourcing is increasingly a defensive move. A state that continues to apply cost-of-performance standards risks putting its businesses at a competitive disadvantage if states that are major trading partners apply market-based sourcing. For example, Oregon is sandwiched between California and Washington, each of which has larger populations and economies, and each of which uses a version of market-based sourcing. Some Oregon-based businesses that export services to California or Washington run the risk of double taxation.”

Manicke also points out that the political case to be made for these changes is easy to understand, stating, “Proponents will always have the political argument that market-based sourcing exports a state’s tax burden to remote businesses, and away from in-state voters.”

The simplest rationale for these changes is to raise tax revenue for the states. Kalafat points out, “The market-based sourcing rules are generally expected to bring in more revenue for Montana. Indeed, the state’s fiscal analysis for the originally introduced bill projected additional revenue of $450,000 for fiscal year 2019, and $1,500,000 additional revenue per year for fiscal years 2020 and 2021.” However, as reported by Paul Shukovsky in the Daily Tax Report (subscription required), while the Oregon bill is expected to produce new revenue for the state, the gains are not expected to be very large, noting that the weighted average of five other states’ estimates showed approximately 1 percent in tax revenue growth after instituting market-based sourcing.

Shukovsky also describes another potential procedural issue highlighted by Oregon Senate Republican Communications Director Jonathan Lockwood with the Oregon legislation: “as a revenue-raising measure, it should have originated in the House and passed by three-fifths majorities in both chambers,” and could therefore be open to legal challenge. However, Manicke discounts this possibility based on the complexity of the particular issue, saying, “Oregon’s legal standard to evaluate whether a bill constitutes a ‘bill for raising revenue’ is difficult to apply in the context of an existing tax regime. The more complex the tax, the harder it is to identify when a bill that modifies it has the ‘essential features’ of a bill levying a tax.”

While the fiscal impact of the implementation of these new sourcing laws is unknown, it appears that the trend is likely to continue based on the new MTC model statutes, the concern for local businesses, the desire for new revenue, and the convenient political justification for moving to market-based sourcing.

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: Will states eventually reach uniformity with market-based sourcing?

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