Massachusetts' Move to Market Sourcing

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By Catherine A. Battin, Richard C. Call, and Joanna Troy

Catherine A. Battin and Richard C. Call are partners and Joanna Troy is an associate in McDermott Will & Emery's state and local tax practice.

Until 2014, Massachusetts utilized a UDITPA-like costs-of-performance rule for sourcing receipts from sales other than sales of tangible personal property, i.e., services and intangibles. Massachusetts adopted a “market-based” sourcing rule effective for tax years beginning on or after Jan. 1, 2014. In 2015, the Massachusetts Department of Revenue (department) issued a final regulation regarding the new sourcing provisions that the Multistate Tax Commission and other states have looked to as a model.

In this article, we review the old sourcing regime and examine the new statute. We also examine the department's new regulation--which contains multiple throwout provisions, an approximation provision and a compliance safe harbor. We also consider sourcing provisions in the regulation related to digital goods and services, software transactions and income from intangibles as well as other provisions.

The Old Regime: Operational
Approach to Costs of Performance

The former Massachusetts statute provided that “sales, other than sales of tangible personal property, are in this commonwealth if: 1. the income-producing activity is performed in this commonwealth; or 2. the income-producing activity is performed both in and outside this commonwealth and a greater proportion of this income-producing activity is performed in this commonwealth than in any other state, based on costs of performance.”1

The meaning of “income-producing activity” was critical to the former statute. For instance, the application of some interpretations of income-producing activity could produce a sourcing figure that one might have equated with a market sourcing rule.2

Regarding the term “income-producing activity,” the former regulation provided:

[A]n income-producing activity is a transaction, procedure, or operation directly engaged in by a taxpayer which results in a separately identifiable item of income. In general, any activity whose performance creates an obligation of a particular customer to pay a specific consideration to the taxpayer is an income-producing activity. However, except [for] the licensing of intangibles[], income-producing activity includes only the activities of the taxpayer whose income is being apportioned. Except as [otherwise] provided …, income-producing activity does not include activities performed on behalf of a taxpayer by another person, such as services performed on its behalf by an independent contractor or by any other party whose activities are not attributable to the taxpayer for purposes of determining tax jurisdiction…. For example, in the case of a taxpayer who brokers the sale of services that are performed by third parties, the income-producing activity includes only the brokerage activity and not the ultimate services performed, provided that the performance of the ultimate service by the third party is not considered an activity of the taxpayer under [the Massachusetts regulations] for purposes of determining whether the taxpayer is taxable in the state where the service is performed.3


In determining the income-producing activity, the Appellate Tax Board (board) and Massachusetts courts have applied an “operational” type approach. This arose in the Boston Prof'l Hockey Ass'n case in which the Supreme Judicial Court upheld the board's decision that the taxpayer's “essential income-producing activity, the operation of an NHL franchise, occurred in Massachusetts.”4 The Supreme Judicial Court stated that the taxpayer was the owner and operator of the Boston Bruins with its principal place of business in Boston.5 The taxpayer argued that “each Bruins game, both home and away, constitutes a separate 'income-producing activity,’ the costs of which must be individually analyzed to determine whether any of the gate receipts should be allocated to Massachusetts.”6 The Supreme Judicial Court affirmed the board's findings that “the 'income-producing activity’ was the 'operation of an NHL franchise,’ not just the playing of individual games,” and that “even if each game were treated as a separate income-producing activity, [the taxpayer] only received gate receipts when the Bruins played home games, and those receipts were received entirely in Massachusetts where the costs of playing the games were also incurred.”7

In 2008, on remand from the Massachusetts Appeals Court, the board in Interface reaffirmed a finding that the taxpayer's “income-producing activity is most appropriately described as its overall tour charter business, rather than its sales of individual, unrelated vacation packages.”8 The board addressed costs of performance for a public charter tour operator that packaged tours in the Caribbean and Mexico and had a regular place of business in Massachusetts.9 The taxpayer argued that “each individual sale must be separately analyzed to determine whether the sale proceeds should be allocated to Massachusetts.”10 The board found that “the activity in which [the taxpayer] was directly engaged was its negotiating, purchasing, assembling, and marketing of travel tours” and that the commissioner “properly characterized [the taxpayer's] income-producing activity as its overall operation of a public charter tour business.”11 The board's decision was affirmed by the Massachusetts Appeals Court, which noted that the board upheld the commissioner's “use of the 'operational’ approach.”12

In 2011, the board considered “whether certain receipts from [AT&T's] interstate and international telecommunications services provided by the appellant should be included in the numerator of the appellant's sales factor for purposes of determining its Massachusetts taxable income for the tax years at issue.”13 The board found that “AT&T met its burden of proving that it incurred greater costs of performance in one single state other than in Massachusetts.”14 The board explained that “when a taxpayer is engaged in the sale of services, calculation of its sales factor requires a determination first of the taxpayer's so-called 'income-producing activity’” and that “[o]nce the income-producing activity is determined, then the 'costs of performance’ of that activity are analyzed to determine if the taxpayer incurred more of those costs in Massachusetts than in any other single state.”15 The commissioner argued for a “transactional approach.” Under this approach, “the Commissioner would thus analyze AT&T's receipts, derived from its customers located in Massachusetts, on a per-transmission basis” due to “the fact that AT&T's bills to its customers were based on discrete transactions.”16 AT&T argued for an “operational approach” asserting that “it engaged in numerous activities…both within and without Massachusetts that were necessary to the overall activity of operating and managing the network.”17 The board “found and ruled that the operational approach was the proper method for determining AT&T's costs of performance for purposes of calculating its sales factor.”18 The board's decision was upheld by the Massachusetts Appeals Court.19

The New Statute

Basic Framework.

The new statutory sourcing provision begins by stating that: “Sales, other than sales of tangible personal property, are in the commonwealth if the corporation's market for the sale is in the commonwealth.”20 It continues with the statement that “the corporation's market for a sale is in the commonwealth and the sale is thus assigned to the commonwealth for the purpose of this section” for the following five categories of receipts:

• (1) in the case of sale, rental, lease or license of real property; if and to the extent the property is located in the commonwealth;

• (2) in the case of rental, lease or license of tangible personal property, if and to the extent the property is located in the commonwealth;21

• (3) in the case of sale of a service, if and to the extent the service is delivered to a location in the commonwealth;

• (4) in the case of lease or license of intangible property, including a sale or exchange of such property where the receipts from the sale or exchange derive from payments that are contingent on the productivity, use or disposition of the property, if and to the extent the intangible property is used in the commonwealth; and

• (5) in the case of the sale of intangible property, other than as provided in clause (4), where the property sold is a contract right, government license or similar intangible property that authorizes the holder to conduct a business activity in a specific geographic area, if and to the extent that the intangible property is used in or otherwise associated with the commonwealth; provided, however, that any sale of intangible property, not otherwise described in this clause or clause (4), shall be excluded from the numerator and the denominator of the sales factor.


Multiple Throwout Provisions.

The new statute contains multiple throwout provisions. First off, the “sale” of types of intangible property, not otherwise addressed in the statute “shall be excluded from the numerator and the denominator of the sales factor.”22 Thus, a taxpayer who derives receipts not specifically addressed in the statute may be subject to this provision and should consider potential challenges to the statute.

The other throwout rule addresses two different scenarios. The statute provides that “if the taxpayer is not taxable in a state to which a sale [of other than tangible personal property] is assigned,” the receipts from the sale are thrown out.23 Alternatively, “if the state or states to which such sales should be assigned cannot be determined or reasonably approximated,” the receipts are thrown out.24

The throwout provision based on taxability in a state to which a receipt is assigned is concerning for multiple reasons. As a preliminary matter, this provision is constitutionally questionable on external consistency grounds because it bases a taxpayer's apportionment (i.e., a reasonable approximation of what a taxpayer does in Massachusetts) on what the taxpayer does in another state, not on what occurs in Massachusetts.

Regarding taxability in another state, the statute provides that “a corporation is taxable in another state if (1) in that state such corporation is subject to a net income tax, a franchise tax measured by net income, a franchise tax for the privilege of doing business, or a corporate stock tax, or (2) that state has jurisdiction to subject such corporation to a net income tax regardless of whether, in fact, the state does or does not.”25 Although the throwout provision may not be externally consistent, this definition of taxable in another state may reduce the practical effect of the provision, especially considering that the Massachusetts courts have adopted an economic nexus approach to income taxes. Therefore, a taxpayer that has such receipts assigned to another state may be able to argue that, for purposes of the Massachusetts rules, the department should consider a taxpayer to be taxable in that state to the extent that the department would assert nexus if the corporation had receipts assigned to Massachusetts.26

Approximation Provision.

Many taxpayers struggle with compliance issues associated with the new market-based sourcing provision. In particular, taxpayers may not have the necessary information from or about their customers to make certain determinations.27 For perhaps these and other circumstances, the new statute provides “in the case of sales, other than sales of tangible personal property, if the state or states to which sales should be assigned cannot be determined, it shall be reasonably approximated.”28

The reasonable approximation provision was the subject of some discussion during the regulatory process. Following the initial draft of the proposed regulation, the department modified the proposal regarding the taxpayer's ability to use a “reasonable approximation” method. The initial draft regulation provided taxpayers with the ability to use a “reasonable approximation” when “the state or states of assignment” could not be determined.29 The final regulation provides that a taxpayer must, “using a reasonable amount of effort undertaken in good faith,” apply the primary rule applicable to the sale (e.g., the specific assignment rules for in-person services, professional services, or sales to, by, or through a customer) before it may reasonably approximate.30 The final regulation further provides that a method of reasonable approximation “must reflect an attempt to obtain the most accurate assignment of sales consistent with the regulatory standards set forth in [the regulation], rather than an attempt to lower the taxpayer's tax liability.”31 There is no guidance as to how a taxpayer would demonstrate that its reasonable approximation attempt was made to “obtain the most accurate assignment of sales.” This raises a number of questions--for example, if a taxpayer determines that there are two equally reasonable methods by which it can approximate its Massachusetts sales, can it use the method that results in less tax? Additionally, there does not seem to be any converse requirement that the department make a similar demonstration (i.e., that any modifications to a taxpayer's sourcing methodology not be an attempt to increase a taxpayer's liability) when exercising its authority to adjust a taxpayer's return.32

Compliance Safe Harbor.

Importantly, the revised regulation also provides new safe harbors in an attempt to address concerns related to the difficulty of compliance and record-keeping requirements, particularly in the context of services provided to business customers by electronic means. Many providers of electronically delivered services do not track, and do not have the means to track, where their service is ultimately delivered to or received by its customers (particularly in the case of large business customers). Under the safe harbor for electronically delivered services (which applies only to services delivered to a business customer), “a taxpayer may assign its sales to a particular customer based on the customer's billing address in any taxable year in which the taxpayer (1) engages in substantially similar transactions with more than 250 customers, whether business or individual, and (2) does not derive more than 5% of its sales of services from such customer.”33 A similar safe harbor also was created for professional services delivered to business customers.34

The New Regulation

The new statute states that the “Department shall adopt regulations to implement this section.”35 What was surprising is just how much detail the department's regulations contained. As adopted, the regulations are 74 pages long, compared to a relatively short statute. This will almost certainly lead to challenges to the department's regulatory authority on the grounds that the regulations exceed the scope of the statute.36

Digital Goods or Services.

The regulation provides that the receipts from the sale or license of digital goods or services, including, among other things, the sale of various video, audio and software products or similar transactions “shall be assigned by applying the same rules … as if the transaction were a service delivered to an individual or business customer or delivered through or on behalf of an individual or business customer.”37 The regulation further provides that “it is not relevant what the terms of the contractual relationship are or whether the sale or license might be characterized, depending upon the particular facts, as, for example, the sale or license of intangible property or the performance of a service.”38

The department's treatment of digital goods as other than tangible personal property is consistent with its position in the sales tax area. Specifically, departmental guidance provides that digital products are not subject to sales tax.39

Software Transactions.

The new regulation provides that: “A license or sale of pre-written software for purposes other than commercial reproduction (or other exploitation of the intellectual property rights), when transferred on a tangible medium, is treated as the sale of tangible personal property, rather than as either the license or sale of intangible property or the performance of a service.”40 The regulation further provides that: “In such cases, the receipts are in Massachusetts as determined under the rules for the sale of tangible personal property … .41 The regulation states that: “In all other cases, the receipts from a license or sale of software are to be assigned to Massachusetts as:”

 1. The sale of custom software;

 2. A license of a marketing intangible;

 3. A license of a production intangible;

 4. A license of intangible property where the substance of the transaction resembles a sale of goods or services; or

 5. A sale of intangible property.42


The Massachusetts sales tax statute treats the sale of “standardized computer software” as a sale of tangible personal property, but the Massachusetts sales tax regulations use the word “pre-written software.”43 It will be interesting to see how the department attempts to apply these terms for the different tax types.

Income from Intangibles.

The former regulation provided that: “In the case of the licensing of intangible property, the income-producing activity is deemed to be performed in the commonwealth to the extent that the intangible property is used by the licensee in the commonwealth.”44 Interestingly, the new regulation also provides that the “receipts from the license of intangible property are in Massachusetts if and to the extent the intangible is used in Massachusetts.”45 Thus, use is a core element of both the old and new regulations when it comes to the sourcing of receipts from licensing of intangible property.

Moreover, the old and new regulations have much of the same framework and language regarding the “use” attribution rules. The former regulation had a framework consisting of marketing and non-marketing intangibles, as well as mixed intangibles.46 The new regulation contains a framework consisting of (1) marketing intangibles, (2) production intangibles, and (3) mixed intangibles.47

Regarding marketing intangibles, the former regulation and new regulation have virtually identical first sentences:

Where a license is granted for the right to use intangible property in connection with the sale, lease, license, or other marketing of goods, services, or other items (i.e., a marketing intangible), the royalties or other licensing fees paid by the licensee for such right are attributable to the commonwealth to the extent that the fees are attributable to the sale or other provision of goods, services, or other items purchased or otherwise acquired by Massachusetts customers.48


The former regulation then provides:

In the absence of actual evidence of the licensee's receipts derived from Massachusetts customers, the licensing fee will be attributed to the commonwealth based upon the percentage of the Massachusetts population in the geographic area in which the licensee is permitted to use the intangible property to market its goods, services or other items.49


Unlike the former regulation, the new regulation has a lot of additional verbiage for cases when actual evidence is absent. In particular, it premises the sourcing on where the “licensee makes material use,” as set forth below:

In the absence of actual evidence of the amount or proportion of the licensee's receipts that are derived from Massachusetts customers, the portion of the licensing fee to be assigned to Massachusetts shall be reasonably approximated by multiplying the total fee by a percentage that reflects the ratio of the Massachusetts population in the specific geographic area in which the licensee makes material use of the intangible property to regularly market its goods, services or other items relative to the total population in such area.50


It will be interesting to see how the department will apply the new regulation as compared to the old regulation and, more specifically, how the department will attempt to apply the “material use” provision.

Regarding non-marketing intangibles, the former regulation provided:

Where a license is granted for the right to use intangible property other than in connection with the sale, lease, license, or other marketing of goods, services, or other items (i.e., a non-marketing intangible), the licensing fees paid by the licensee for such right are attributable to the commonwealth to the extent that the use for which the fees are paid takes place in Massachusetts.51


The only difference in the first sentence of the new regulation (other than calling it a production intangible instead of a non-marketing intangible) is that these rules apply to “license[s]… to be used in a production capacity.”52 This leaves open the question of whether there could be some type of intangibles other than a marketing intangible, production intangible, or mixed intangible--presumably, there are intangibles that the old regulation would have considered non-marketing intangibles, which are not considered production intangibles under the new regulation.

Sales Factor Consistency.

The new regulation provides that: “A taxpayer must use the same rules for excluding or including gross receipts in both the numerator and the denominator of the sales factor.”53 The regulation further provides that: “If the taxpayer changes its method of excluding or including gross receipts in the sales factor from the method used in its return in the prior year, the taxpayer must disclose in the return for the current year the fact of such change, the nature and extent of the change, and the reason for the change.”54 The regulation permits the commissioner to “disregard changes in the current year or in future tax years if they have not been adequately disclosed.”55 Depending on how this is applied, it may place a significant burden on the taxpayer to get this right the first time--remember that the regulation was not adopted until Jan. 2, 2015, after the first tax year under the new regime had ended, but before returns were due. Therefore, taxpayers who had little time to prepare their 2014 returns may be faced with a disclosure requirement as they take more time to work through the rules for their 2015 filings.


Massachusetts now has relatively lengthy guidance on its market-based sourcing regime. Interestingly, the Multistate Tax Commission used the Massachusetts regulation as the starting point in drafting its own model regulation. It remains to be seen how many other states will adopt similar regulations or whether there will be differences among the states that could lead to instances of double taxation for taxpayers.

1 G.L. c. 63, § 38(f) (amended 2013). The former regulation provided that: “Sales, other than sales of tangible personal property, are attributed to Massachusetts if the income-producing activity that gave rise to the sales was performed wholly within Massachusetts. If income-producing activity is performed both within and without Massachusetts and if the costs of performing the income-producing activity are greater in Massachusetts than in any other one state, then the sales are attributed to Massachusetts.” 830 CMR 63.38.1(9)(d)1 (former regulation effective until tax years beginning on or after Jan. 1, 2014; hereinafter all citations to the former regulation will include a parenthetical stating “former regulation.” Citations to the regulation that do not include that parenthetical are citations to the regulation as currently in effect).

2 See, e.g., Ameritech Publishing, Inc. v. Dept. of Revenue, 788 N.W. 2d 383 (Wisc. Ct. App. June 24, 2010).

3 830 CMR 63.38.1(9)(d)2 (former regulation).

4 Boston Prof'l Hockey Ass'n v. Comm'r of Revenue, 443 Mass. 276, 298 (2005).

5 Id. at 278.

6 Id. at 283.

7 Id. at 284.

8 Interface Group v. Comm'r of Revenue, Mass. App. Tax Bd. Dkt. Nos. C266670-76, C266680, C266677-79 (Oct. 17, 2008).

9 Id.

10 Id.

11 Id.

12 Interface Group v. Comm'r of Revenue, 75 Mass. App. Ct. 1116 (2009).

13 AT&T Corp. v. Comm'r of Revenue, Mass. App. Tax Bd. Dkt. No. C293831 (June 8, 2011) at 544.

14 Id. at 542.

15 Id. at 526-27.

16 Id. at 527-28.

17 Id. at 528.

18 Id. at 558.

19 Comm’r of Revenue v. AT&T Corp., 82 Mass. App. Ct. 1106 (2012).

20 G.L. c. 63, § 38(f).

21 It is unclear how the “rental, lease or license of tangible personal property” would be considered a “sale” of other than tangible personal property. G.L. c. 63, § 38(f). “Sales” is defined elsewhere in the statute as “all gross receipts of the corporation, including deemed receipts from transactions treated as sales or exchanges under the Code, except interest, dividends and gross receipts from the maturity, redemption, sale, exchange or other disposition of securities . …” Id.

22 G.L. c. 63, § 38(f).

23 Id.

24 Id.

25 G.L. c. 63, § 38(b).

26 See, e.g.,Lorillard Licensing Co., LLC v. Director, Docket No. A-2033-13T1 (N.J. Super. Ct. App. Div. Dec. 4, 2015).

27 See American Cyanamid and Chemical Corp. v. Comptroller, 308 N.Y. 259 (1955).

28 G.L. c. 63, § 38(f).

29 Working Draft for Practitioner Comment, 830 CMR 63.38.1(9)(d)1.b (issued Mar. 25, 2014).

30 830 CMR 63.38.1(9)(d)1.f.i.

31 830 CMR 63.38.1(9)(d)1.d.iii.

32 Take Two: Massachusetts Department of Revenue Releases Revised Market-Based Sourcing Regulation, Catherine A. Battin, Maria P. Eberle and Lindsay M. LaCava, Inside SALT, McDermott Will & Emery (Nov. 7, 2014),

33 830 CMR 63.38.1(9)(d)4.c.ii(B)2.d.

34 830 CMR 63.38.1(9)(d)4.d.iii(A)2.

35 G.L. c. 63, §38(f).

36 For a case involving the department's regulatory authority, see 131 Willow Avenue, LLC v. Comm'r of Revenue, 2015 WL 6447310 (Mass. Sup. Ct. 2015).

37 830 CMR 63.38.1(9)(d)7.b.i.

38 Id.

39 TIR 05-8, Section VII. B.8 (July 14, 2005) (“Digital products other than software that are delivered electronically, including but not limited to music, video, reading materials or ring tones” are not subject to sales tax.)

40 830 CMR 63.38.1(9)(d)7.a.

41 Id.

42 Id.

43 G.L. c. 64H, § 1; 830 CMR 64H.1.3(2).

44 830 CMR 63.38.1(9)(d)3.c (former regulation) (emphasis added).

45 830 CMR 63.38.1(9)(d)5.a.i (emphasis added).

46 830 CMR 63.38.1(9)(d)3.c.ii (former regulation).

47 830 CMR 63.38.1(9)(d)5.

48 830 CMR 63.38.1(9)(d)5.b; see 830 CMR 63.38.1(9)(d)3.c.ii(A) (former regulation).

49 830 CMR 63.38.1(9)(d)3.c.ii(A) (former regulation).

50 830 CMR 63.38.1(9)(d)5.b.

51 830 CMR 63.38.1(9)(d)3.c.ii(B) (former regulation).

52 830 CMR 63.38.1(9)(d)5.c (emphasis added).

53 830 CMR 63.38.1(9)(d)7.f.

54 Id.

55 Id.

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