On December 23rd, the Rhode Island Division of Taxation issued final regulations, R.I. Regs. § CT 15-04, that are voluminous, complicated and bring no more clarity to issues that taxpayers are facing with respect to market-based sourcing schemes (247 DTR H-2, 12/28/2015).
On June 9, 2014, Rhode Island enacted a single-sales factor apportionment method and market-based sourcing for sales of other than tangible personal property for tax years beginning on or after Jan. 1, 2015. For sales of other than tangible personal property, the receipts are sourced to Rhode Island if, and to the extent, that the corporation’s market for the sale is in the state. For sales of services, this means the receipt is sourced to the state where the recipient of the service received the benefit. R.I. Regs. § CT 15-04(8)(a)
In applying the regulations, a taxpayer must first make a ‘reasonable effort’ to apply the primary rule provided before attempting to apply a secondary rule or the rule of reasonable approximation. Absent a specific rule for reasonable approximation, a taxpayer may use a method that ‘reflects an effort to approximate the results that would be obtained under the applicable rules.’ R.I. Regs. § CT 15-04(8)(i)(8)(A)
Receipts from Services
In sourcing receipts from in-person services, the taxpayer must first use the location where the service was performed on either a customer’s physical person, real estate or tangible personal property. If that cannot be readily determined, the taxpayer must reasonably approximate where the benefit of the service was received. R.I. Regs. § CT 15-04(8)(i)(8)(B)(i)(a)
Services delivered to, on behalf of a customer by physical means or electronically to or through a customer are sourced to Rhode Island to the extent the service is delivered in the state. A service delivered electronically on behalf of a customer is a look-through to third-parties who are the actual recipients of the service. R.I. Regs. § CT 15-04(8)(i)(8)(B)(ii)
Services Delivered By Physical Means
Receipts from services delivered to or on behalf of a customer by physical means are sourced to the state where the service is delivered. According to the regulations, such services include the direct mail services, the delivery of advertising-related services, and the sale of custom software. Where the taxpayer cannot determine the state of delivery, it should use a method of reasonable approximation. R.I. Regs. § CT 15-04(8)(i)(8)(B)(ii)(a)(I)
Services Delivered By Electronic Transmission
Services delivered by electronic transmission are sourced to Rhode Island if the customer receives the service in the state. If such information is not available, then the taxpayer should use a reasonable method of approximation to source the receipt to the state where the benefit of the service is received. R.I. Regs. § CT 15-04(8)(i)(8)(B)(ii)(a)(II)(A) and (B)
The rule of reasonable approximation for services delivered electronically differs when such information is unavailable based on whether the service provider’s customer is an individual or a business. In the case of an individual customer, the taxpayer may use the individual customer’s billing address as the method of reasonable approximation. R.I. Regs. § CT 15-04(8)(i)(8)(B)(ii)(a)(II)(A) and (B)
When information is not available to source receipts from services delivered electronically to a business customer, the rule of reasonable approximation is based on where the benefit of the service is received. If that information is not available, the service provider must employ a cascading set of rules using the location where the contract is principally managed, the place where the service was ordered or the customer’s billing address. There is a safe harbor that allows the service provider to forego these rules and use the customer’s billing address where more than 250 such transactions are employed and the taxpayer doesn’t derive more than 5% of its receipts from one particular customer. R.I. Regs. § CT 15-04(8)(i)(8)(B)(ii)(a)(II)(B)
Services Delivered Electronically Through or On Behalf of A Customer
A service delivered electronically through or on behalf of a customer is one in which third-parties are the recipient of the service. The regulations provide that the delivery of direct or indirect advertising services would be an example of such services. Such receipts are sourced to Rhode Island to the extent that the end users or third-parties are located in the state. If the taxpayer does not have sufficient information to determine where these third-parties are located, it should use a reasonable method to approximate where the benefit of the service is received. R.I. Regs. § CT 15-04(8)(i)(8)(B)(ii)(a)(III)(A)
Absent such information, the regulations provide multiple secondary rules of reasonable approximation based on the type of service delivered. For advertising services, the taxpayer should approximate the percentage of subscribers who receive service or the percentage of subscribers in a specific geographic area depending on the information available. The regulations provide additional approximation rules for permutations on intermediary service providers. R.I. Regs. § CT 15-04(8)(i)(8)(B)(ii)(a)(III)(C)
Professional services, those services that require specialized knowledge and often certifications, licenses or degrees, are not susceptible to a default rule of determination according to the regulations and must be sourced based on a method of reasonable approximation. It should be noted that where a service may be treated as both an in-person service and a professional service, the receipts should be sourced under the professional service rules. The sourcing rules for professional services differ based on whether the customer is an individual or a business and the regulations provide a safe harbor for taxpayers with a large volume of such transactions. Further, specific rules are in place for architectural and engineering services related to real and tangible personal property. R.I. Regs. § CT 15-04(8)(i)(8)(B)(iii)
Finnigan and Throwback Rules
Rhode Island has chosen to employ the Finnigan method for apportioning the income of members of the combined group who lack nexus or otherwise protected by P.L. 86-272. The Rhode Island receipts of a combined group member who lacks nexus must be included in the numerator of the combined group’s single-sales apportionment factor. In determining what is a Rhode Island receipt for those non-nexus members, the market-based regulations under Rhode Island. R.I. Regs. § CT 15-04(8)(i) are used.
Applicability of Regulations to Combined Groups
For tax years beginning on or after Jan. 1, 2015, the apportionment regulations apply to all C corporations and combined groups that include at least one C corporation that derive income from sources both within and outside of Rhode Island. R.I. Regs. § CT 15-04(8)(a)
The full text of the final regulations can be found here:
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