Indiana: College Tuition Paid for Out-of-state Online Courses Not Sourced in State of Students

Daily Tax Report: State provides authoritative coverage of state and local tax developments across the 50 U.S. states and the District of Columbia, tracking legislative and regulatory updates,...

Tax Policy

Bloomberg BNA regularly spotlights the insights of state and local tax attorneys at KPMG LLP. In this installment, Sarah McGahan discusses a case of first impression in the Indiana Tax Court.

Sarah McGahan

By Sarah McGahan

Sarah McGahan is director in the State and Local Tax group of KPMG LLP's Washington National Tax practice.

In a case of first impression, the Indiana tax court recently rejected the Department of Revenue's position that an out-of-state service provider's receipts from Indiana customers should be sourced to the state.

The taxpayer in the University of Phoenix v. Indiana, Dep't of State Revenue, was a Phoenix-based online university and the receipts were from online students with an Indiana billing address. Under Indiana law, sales (other than sales of tangible personal property) are sourced to Indiana if the income-producing activity is performed in Indiana. If the income-producing activity is performed in other states as well as Indiana, then the receipt is sourced to Indiana if a greater proportion of the income-producing activity giving rise to the income is performed in Indiana than in any other state, based on costs of performance.

The Department argued that it did not need to review costs of performance because the income-producing activity took place only in Indiana. The taxpayer argued that the Department's proposed assessments were incorrect because it engaged in several separate income-producing activities that were performed both inside and outside of Indiana, with the greater proportion of the cost of performance of those activities outside the state. The taxpayer's expert witness, a cost accountant, presented a detailed cost study supporting the taxpayer's claimed income-producing activities and their allocation across states.

Definition Not Consistent

The Department focused only on the taxpayer's activities of providing a student the opportunity to attend an online class in return for the student's payment for that class. In the tax court's view, this definition was not consistent with the use of the term “income-producing activity” in the sourcing statute or its interpretive regulation. The court also noted that the Department did not present any probative evidence to support its own claims or to rebut the taxpayer's evidence.

The court next held that the taxpayer's income-producing activities occurred both in Indiana and other states, and that the Department erred by automatically applying a market-based sourcing method (assigning all the receipts to Indiana), rather than analyzing where the applicable costs of performance occurred.

Cost Study Probative

Finally, the tax court held that the taxpayer's cost study was probative evidence that persuasively demonstrated that the greater proportion of its costs of performance were outside of Indiana.

The decision was identified as “For Publication,” meaning it is precedential.

This is far from the only instance in which the Department has assigned receipts from similar activities entirely to Indiana by narrowly looking at only the activities in Indiana. As a result of the tax court's decision, there may be opportunities to apply similar reasoning to achieve an assignment of sales to states other than Indiana. A review of the decision, however, makes it clear that the taxpayer's extensive study and documentation of its income-producing activity and costs of performance were critically important to the outcome.

The information in this article is not intended to be “written advice concerning one or more federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230 because the content is issued for general informational purposes only. The information contained in this article is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax advisor. This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG LLP.

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