New england market based sourcing

New England Market Based Sourcing

Shirley Grimmett Jane SteinmetzNovember 16, 2016

Top Sales Factor Sourcing Issues

SALT Financial Services Technical Update

Sales Factor Sourcing Issues

► Many states have recently enacted market based sourcing (MBS) yet have not released guidance regarding their interpretation of it.► States that have released guidance are taking conflicting approaches, which

could result to more than 100% of income being taxed by states.► Some would argue that states traded one set of issues under the cost

of performance rule for another set of issues.► MBS states are uniformly attempting to source to the market, yet

subtle differences in statutory language are driving different approaches.

► When tied to economic nexus, MBS can increase the filing requirements of taxpayers.

► Industry nuances are driving conflicting interpretations and the need for explicit guidance.

National Trend Towards Market-Based Sourcing


UDITPA Section 17 – cost of performance language

► Section 17 of the Uniform Division of Income for Tax Purposes Act (UDITPA) provides the method of sourcing for sales of “other than tangible personal property” if:► The income-producing activity is performed in the taxing state;

or► The income-producing activity is performed both in and

outside the taxing state and a greater proportion of the income-producing activity is performed in the taxing state than in any other state, based on costs of performance


Cost of performance

► Cost of performance (COP) is a “winner take all rule”► From the beginning, the Section 17 COP sourcing rule for services and

intangibles was controversial.► Does not reflect the contribution of the market states► COP sources receipts to production states► Subjectivity on allocating costs among states

► COP reflected practical realities of the 1950’s when adopted► Economy was more mercantile and manufacturing oriented► Major service industries excluded from UDITPA

► Financial organizations (banks, insurance companies)► Public utilities


What is market-based sourcing (MBS)?

► Objective ► Source receipts from sales, other than sales of TPP, to location of ‘market’

► Query the policy goal► Tax out-of-state companies more heavily?► Create level playing field that taxes in-state and out-of-state companies

based on their customers in the state versus their investments in the state. ► More accurately reflect business activities in state?► Already use MBS to source sales of TPP, so why not use MBS for

everything else?► Bring tax statutes in line with modern economy?


2000: sourcing of multistate service revenue

AK

HI

ME

RI

VTNHMANY

CT

PANJ

DC

DEWV

NC

SC

GA

FL

ILOHIN

MIWI

KY

TN

ALMS

AR

LATX

OK

MOKS

IA

MN

ND

SD

NE

NMAZ

COUT

WY

MT

WA

ORID

NV

CAVA

MD

Source to state where greater portion of income producing activity performed (“all or nothing”)

Source to state to the extent services performed in state (“to the extent of” or “direct”)

Source to state where benefit of service received (“benefit” or “market”)

No income tax


2016: sourcing of multistate service revenue

AK

HI

ME

RI2015

VTNH

MA2014

NY2015

PA2014 NJ

DC 2015

DEWV

NC

SC

GA

FL

IL OHIN

MIWI

KY

TN 2016

ALMS

AR

LATX

OK

MOKS

IA

MN

ND

SD

NE2014

NMAZ2014

COUT

WY

MT

WA

ORID

NV

CAVA

MD

As of July, 2016

Source to state where greater portion of income producing activity performed (“all or nothing”)

Source to state to the extent services performed in state (“to the extent of” or “direct” )

Source to state where benefit of service received (“benefit” or “market”)

No income tax

CT2016


Trading one set of problems for another

► What are “income producing activities”► What “direct costs” should be

counted?► Match costs to revenue?► Third-party costs included?

► Where (i.e., in which state) were the direct costs incurred?

► What does market mean?► Where customer located?► Where benefit of the service is

received?► Where intangible property is used?

► Which receipts are measured?► Treasury receipts?

Cost of performance Market-based sourcing


Judicial cases highlighting the problem

► AT&T Corp v. Comr. of Rev., No. C293831 (Mass. App. Tax Bd. June 2011) ► AT&T properly sourced its sales under the COP method because its

income-producing activity was the operation of its long-distance telecommunications network and not each individual long-distance transmission placed by the customer

► AT&T Corp. v. Dept. of Rev., (Ore. Tax Ct., No. TC 4814 June 2011) ► The Tax Court determined that AT&T was required to use the transactional

approach when analyzing AT&T’s cost of performance incurred in providing telecommunications services because the relevant income-producing activity is each individual call that originated and terminated in Oregon

► How do you reconcile diametrically opposed rulings on the exact, same facts?


States’ varying approaches to market-based sourcing

► Benefits – received approach► Assigns receipts from services to the state where the benefit

of the services was received

► Services – delivered approach► Assigns receipts from services to the state in which the

service was delivered or received

► Receipts – derived approach ► Assigns receipts from services to a state if the service

provider derived receipts from the state’s market


States’ market-based sourcing approaches

Benefits-received states

Services-delivered states

Receipts-derived states

Arizona Alabama GeorgiaCalifornia Connecticut *June

2016Maryland

Iowa Illinois NebraskaMichigan Maine OklahomaNew York MassachusettsRhode Island MinnesotaUtah PennsylvaniaWisconsin Tennessee

as of 1 January 2016

Market Based Sourcing in New England


Market Based Sourcing vs. Cost of Performance

Market Based Sourcing Cost of Performance

► Connecticut (new for 2016)

► Massachusetts

► Maine

► Rhode Island (new for 2015)

► New Hampshire

► Vermont

http://www.google.com/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&ved=0ahUKEwiQmbLgmefPAhVJ2yYKHe2MBJsQjRwIBw&url=http://www.enchantedlearning.com/usa/states/massachusetts/&bvm=bv.136499718,bs.2,d.eWE&psig=AFQjCNGQlc4LTxvqN5-jh1jIaIjkM-CMxQ&ust=1476977944762363

https://www.google.com/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&ved=0ahUKEwjlscyVmufPAhVL4iYKHZ3MC3oQjRwIBw&url=https://en.wikipedia.org/wiki/Flag_of_Maine&psig=AFQjCNGQ90Hw8lt4ZjRSomtslAcfJsNfnw&ust=1476978056880037

https://www.google.com/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&ved=0ahUKEwi9rI_hmufPAhURySYKHR--BvEQjRwIBw&url=https://en.wikipedia.org/wiki/Flag_and_seal_of_New_Hampshire&psig=AFQjCNFQKmT0JhGsRIfsQf6vjqTb61KFNQ&ust=1476978214542566

https://www.google.com/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&cad=rja&uact=8&ved=0ahUKEwjRx72qnOfPAhVI5iYKHS_0AUsQjRwIBw&url=https://en.wikipedia.org/wiki/Flag_of_Vermont&psig=AFQjCNG0XrsvF-0SrLVyLETBWJhnq2MX8A&ust=1476978635935881


► Massachusetts has released very specific guidance (discussed infra) on its interpretation of MBS.

► Rhode Island adopted MBS in 2015, modeled after the Massachusetts Rules

► Connecticut has not released MBS regulations. ► Conn. Gen. Stat. § 12-218 (b)(1), “Gross receipts from services are

assignable to this state if the market for services is in this state. The taxpayer's market for the services is in this state if and to the extent the service is used at a location in this state.”

► Maine has released limited guidance, discussed infra. ► Generally, receipts from the performance of services must be sourced to

the state where the services are received.


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Massachusetts MBS


► In 2014, Massachusetts adopted MBS for income from sales other than sales of real or personal property.

► Income from services is sourced to Massachusetts if and to the extent that the service is delivered at a location in Massachusetts.

► The term “delivered” refers to the location of the taxpayer’s market for the service provided and not the location of the property or payroll of the taxpayer.

► Massachusetts divides sales from services into multiple categories:► In-person services ► Professional services► Services delivered to the customer or on behalf of the customer or

delivered electronically through the customer



Massachusetts MBS (cont’d).► In Person Services

► Example - Barbershop, Repair services, cleaning services, landscape services► Services that the service provider physically provides to the customer or the

customer's property (example: barbershop services, home repair services)► Source to location where service is received and performed

► Services Delivered Electronically Through or on Behalf of an Individual or Business Customer—► Services Delivered by Physical Means – e.g., Brochures, advertising services,

custom software installed at a customer’s site► Product delivery services where property is delivered to the customer or to a

third party on behalf of the customer► Sourced based on states where such services are delivered. ► Rule of reasonable approximation applies if service delivery state cannot be

determined.



Massachusetts MBS (cont’d).► Services Delivered By Electronic Transmission to Individual Customer—

► Example – software support via internet► Source to Massachusetts to the extent taxpayer's customer receives

service in Massachusetts. ► Reasonably approximate if service delivery state cannot be determined. ► If cannot reasonably approximate, source to customer's billing address.

► Services Delivered By Electronic Transmission to a Business Customer—► Source to Massachusetts to extent that customer receives service in

Massachusetts. ► Reasonably approximate if service delivery state cannot be determined.

If cannot reasonably approximate, then use cascading rules:► 1) where the contract of sale is principally managed by the customer► 2) customer's place of order► 3) customer's billing address



Massachusetts MBS (cont’d).► If the taxpayer derives more than 5% of its sales of services from a customer,

the taxpayer is required to identify the state in which the contract of sale is principally managed by that customer.

► Safe Harbor Rule – if the taxpayer cannot reasonable approximate the state or states in which the service is received, the taxpayer may in lieu of the cascading rule above, assign the sales based on billing address in any taxable year in which the taxpayer:► Engages in substantially similar service transactions with more than 250

customers, whether individual or business, and► Does not derive more than 5% of its sales of service from such customer.



Massachusetts MBS (cont’d). ► Services Delivered Electronically Through or on Behalf of an Individual or

Business Customer—► Example: advertising by digital means. ► Where the service is delivered electronically to end users or other third-party

recipients through or on behalf of the customer. ► Service is delivered in Massachusetts to the extent that end users or other third-

party recipients are in Massachusetts ► Rule of reasonable approximation applies if service delivery state cannot be

determined. ► Where a taxpayer is delivering advertising to a known list of subscribers, then

reasonably approximate by using a percentage that reflects the ratio of state's subscribers in the specific geographic area relative to the total subscribers in such area;

► If cannot reasonably approximate, use cascading rules:



Massachusetts adopted MBS (cont’d). ► Professional Services. (For example accounting, legal, consulting, graphic design,

bank and financial, tax preparation, payroll and accounting). ► For individual customers, the taxpayer assigns the sale to the customer's state of

primary residence, ► If the taxpayer cannot reasonably identify the customer's state of primary

residence, to the state of the customer's billing address (subject to 5% rule). ► For business customers, unless taxpayer may use the safe harbor rules:

► first, assign receipts to the state where the contract of sale is principally managed by the customer;

► second, if above not reasonably determinable, to the customer's place of order; and

► third, if above not reasonably determinable, to the customer's billing address (subject to 5% rule)

► If the taxpayer cannot determine if a customer is an individual customer or a business customer, the taxpayer shall treat the customer as a business customer.



Massachusetts MBS (cont’d).► Intangible Personal Property► Receipts from the license of intangible property are in Massachusetts

to the extent the intangible property is used in Massachusetts. ► Intangible property is classified as follows:

► Marketing Intangible (service marks, trademarks, trade names, certain copyrights, films, television, multimedia, etc.

► Production Intangible (patents, copyrights, or trade secrets used in a manufacturing process)

► Mixed Intangible► License of Intangible where substance of transaction resembles a

sale of goods or services



Massachusetts MBS (cont’d).► Marketing Intangible

► Where a license is granted for the right to use such intangible in connection with the sale, lease, license, or other marketing of goods, services or other items, royalties assigned to MA to the extent the fees are attributable to the sale or other provision of goods, services purchased or acquired by customers in MA.

► If the amount of receipts in MA cannot be determined, use reasonable approximation by multiplying the total fee by a percentage that reflects the ratio of the MA population in the specific geographic area relative to the total population used to regularly market the goods.



Massachusetts MBS (cont’d).► Production Intangibles

► Where a license is granted for the right to use such intangible, the licensing fees are assigned to MA to the extent that the use for which the fees are paid takes place in MA.► There is a presumption that the use of production intangibles takes place

in the state of a business licensee’s commercial domicile or an individual licensee’s state of primary residence.

► If it is established that the actual use of a production intangible takes place in MA, there is a presumption that the entire use is in MA, except to the extent the TP can demonstrate the actual location takes place outside MA.



Massachusetts MBS (cont’d).► Mixed Intangibles

► If a license of an intangible property includes both a license of a marketing intangible and a production intangible:► If the fees to be paid are separately and reasonably stated in the licensing

contract, this will be accepted by the DOR.► If the fees to be paid are not separately and reasonably stated in the

contract, there is a presumption that the fees are paid entirely for the licensing of the marketing intangible unless the TP or the DOR can reasonable establish otherwise.



Massachusetts MBS (cont’d).► Transaction resembling electronically sale of goods or services (license of

database access, access to information, digital goods)► In such cases, taxpayer must assign the receipts from such transactions as

if the transaction were a service delivered to an individual or business customer or delivered electronically through an individual or business customer.

► If the customer sublicenses the intangible property to end uses, the taxpayer must assign the receipts as if the transaction were a service delivered electronically through a customer to end users.


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Maine MBS


Maine► Non-business customer. When it is unclear where the services were

received, the sale is deemed to have occurred at the home of the customer.

► Business customer. When it is unclear where the services were received, the sale is deemed to have occurred at the office of the business customer where the services were ordered in the regular course of the customer's trade or business. If the ordering location can not be determined, the sale is deemed to have occurred at the office to which the services were billed.

► Federal government. If the customer is the federal government, the services are deemed to have been received in this State if the greater proportion of the income-producing activity is performed in this State than in any other state based on costs of performance.


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Economic Nexus

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Nexus – economic presence

► Under an economic nexus principle, a state may tax an entity that avails itself of the state’s marketplace, irrespective of whether the entity has a physical presence in the state.

► Many states have adopted economic nexus standards by statute, regulation or judicial decisions, including the following:► Arizona, Arkansas, California, Connecticut, Colorado, Florida, Idaho, Indiana, Iowa,

Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, New Hampshire, New York, New Jersey, New Mexico, North Carolina, Ohio, Oklahoma, Oregon, South Carolina, Washington, West Virginia and Wisconsin

► Economic nexus is controversial, and the subject of litigation across the states.

US state income tax update

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Nexus – economic presence: factor presence

Factor presence standard► A growing number of more aggressive states have enacted “factor presence”

standards to set a bright-line standard as to whether an entity’s activities directed toward the state are sufficient to create nexus.

► Under a typical factor presence test, based on model language from the Multistate Tax Commission (MTC), an entity is taxable in the state if it meets certain thresholds, such as:► $50,000 of property in the state► $50,000 of payroll in the state► $500,000 of receipts in the state

or► 25% of its total property, payroll or sales is in the state


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Nexus – states with factor presence standard

State

Effective for tax years

beginning on or after

Factor presence standards*

In-state sales

In-state property

In-state payroll

In-state property, payroll or sales

California January 1, 2011 $536,446 $53,644 $53,644 25%

Colorado April 30, 2010 $50,000 $50,000 $50,000 25%

Connecticut January 1, 2010 $500,000

Michigan Corporate Income Tax January 1, 2012 $350,000

Ohio – Commercial Activity Tax July 1, 2005 $500,000 $50,000 $50,000 25%

New York State January 1, 2015 $1,000,000

Washington Business and Occupation Tax May 31, 2010 $250,000 $50,000 $50,000 25%


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Nexus – market-based sourcing meets factor presence ► Market-based sourcing rules generally apply to determine receipts in the

state for purposes of bright-line test. In other words, receipts are sourced to the location of the customer:► Troublesome interaction between the rise of economic nexus and market-based

sourcing► Forces changes to filing positions used under historical cost of performance

approach► Market-based sourcing and economic nexus change this calculus► Increased tax and compliance burden on out-of-state businesses


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Industry Nuances

Asset ManagementBroadcasting Telecommunication

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Asset Management


Mutual fund service providers v. other asset managers

► Generally, mutual fund service providers are defined as any corporation that derive gross income from administrative, management or distribution services to regulated investment company (RIC).

► Massachusetts requires a company to derive more than 50% of its gross receipts from such activities to use a single sales factor formula.

► Numerous states have specific rules for qualifying mutual fund service providers that allow them to source qualifying receipts based on the location of the mutual fund shareholders.

► Other asset management services are sourced under the general apportionment rules for services, unless the state released specific industry guidance.

Asset management Sourcing Rules


Mutual Fund Sourcing Rules

Mandatory shareholder

sourcing

Elective shareholder

sourcingNo specific rule

Connecticut XMaine XMassachusetts XNew Hampshire XRhode Island XVermont X


Asset Management Sourcing Rules

Services to:Sourcing

California* Massachusetts Multistate Tax Compact New York

Mutual funds Shareholder Shareholder Fund Shareholder

Retirement and other

institutional accounts

Unclear

(possibly investor)Fund Fund

Unclear

(possibly investor)

Alternative investment

funds

Unclear

(possibly investor)Fund Fund

Unclear

(possibly investor)


Broadcasting & Media


► CT and NH model rule after the MTC► VT and ME do not have special apportionment rules for

broadcasting receipts► RI and MA have rules specific to services delivered electronically

through or on behalf of an individual or business customer ► RI has specific sourcing provisions for broadcasters:

► Receipts of a broadcaster arising from the provision of advertising services are in this State if the commercial domicile of the corresponding broadcast customer is in this State.

► Receipts of a broadcaster arising from fees paid directly by a consumer to the broadcaster for access to the broadcaster's film programming are in this State if the address of the consumer listed in the broadcaster's records is in this State.

► Receipts of a broadcaster arising from license fees paid directly by a Platform Distribution Company are in this State if the commercial domicile of the corresponding broadcast customer is in this State. “Platform Distribution Company” means a cable service provider, a direct broadcast satellite system, an internet content distributor or any other distributor that directly charges viewers for access to any film programming.

Sourcing Receipts from Broadcasting


► MA broadcasting example helps illustrate application► Cable TV (corp. based outside of MA) has two revenue streams:

► Revenue stream 1: sales of advertising time to business customers whereby customers’ commercials run during Cable TV's televised programming. Some of these customers have physical presence in MA. Audience is used to assign receipts to MA.► If Cable TV is unable to determine the actual location of its audience for the

programming, and lacks information to reasonably approximate the location, Cable TV must approximate:

► Use percentage that reflects the ratio of its MA subscribers in the geographic area in which Cable TV’s televised programming featuring such advertisements is delivered relative to its total number of subscribers in such area

► Revenue stream 2: monthly subscriptions to individual customers in MA and other states. ► Sourcing: Subscription would represent sale of a service, and therefore assigned to MA

in any case in which the programming is received by a customer in MA► In any case in which Cable TV Corp cannot determine the actual location where the

programming is received, and lacks sufficient information regarding the location of receipt to reasonably approximate such location, such sales of Cable TV s monthly subscriptions are assigned based on customer's billing address.



► MA broadcasting example helps illustrate application► Network Corp engages in substantially similar activities to Cable TV,

except its advertisements will run as commercials during Network Corp's televised programming as distributed by unrelated cable television and satellite television transmission companies. ► Network Corp's sale of advertising time to its business customers is assigned to

Massachusetts to the extent that the audience for Network Corp's televised programming during which the advertisements will run is in Massachusetts.

► If Network Corp cannot determine the actual location of the audience for its programming and lacks sufficient information regarding audience location to reasonably approximate such location, Network Corp must approximate MA sales by multiplying the amount of such sales by a percentage of MA population in the specific geographic area in which the televised programming containing the advertising is run relative to the total population in such area.



► CT did not change its apportionment rule relating to broadcast of video or audio programming with adoption of MBS

► Apportioned using single sales factor, consisting of numerator which is broadcaster’s gross receipts assignable to CT, and denominator which is broadcaster’s total gross receipts

► The following receipts are assigned to the state:► Gross receipts, including advertising revenue, affiliate fees and subscriber fees,

received by a broadcaster from video or audio programming in release to or by a broadcaster for telecast which is attributed to this state.

► Gross receipts, including advertising revenue, received from video or audio programming in release to or by such network or station for telecast shall be attributed to this state in the same ratio that the audience for such over-the-air network or station located in this state bears to the total audience for such over-the-air network or station inside and outside of the United States.► Audience determined either by reference to books and records of taxpayer; or► By reference to the applicable year's published rating statistics► Method used must be consistently used from year to year for such purpose and fairly

represents the taxpayer's activity in the state.

Sourcing Receipts from BroadcastingConnecticut


► Connecticut (cont’d)

► The above rule applies to Broadcasters, over-the-air television or radio networks, and television or ratio stations.

► Video or audio production programming services (news, sporting events, stories and other entertainment made available for video or audio exhibition through the use of video tape, disc or any other type of format) are in this state if the video or programming services occur in this state.► Numerator = gross receipts derived from such services in this state► Denominator = gross receipts derived from such services which

occur within or without state.



► Connecticut (cont’d)► Concerns

► Cable networks or cable television system► Subscribers are customers of cable television companies.► Possibility of double taxation.



Telecommunications


► Most states do not have specific apportionment rules for the telecommunications industry

► In New England, MA is the only state that has adopted specific rule for sourcing sales from telecommunications receipts, as follows:

► Gross receipts from the sale of such services are in the state when:► Call originates and terminates in this state, or► The call either originates or terminates and the service address is also

located in this state.► Gross receipts from the sale of services sold on a call by call basis

are in this state when:► The customer’s place of primary use is in this state.

► Gross receipts from the sale of mobile telecommunications services are in this state when:► The customer’s place of primary use is in this state

Sourcing Receipts from Telecommunications


► Cascading rule:► Service address is:

► (a) The location of the customer’s telecommunications equipment, to which the customer’s call is charged, and from which the call originates or terminates, regardless of where the call is billed or paid.

► (b) If the location in (a) is not known, service address means the origination point of the signal of the telecom services first identified by either the seller’s telecom system or in information received by the seller from its service provider, where the system used to transport such signals is not that of the seller.

► If the location in (a) and (b) are not known, the service address means the location of the customer’s place of primary use.

Sourcing Receipts from Telecommunications(cont’d.)


► Throwout Rule: Gross receipts from the sale of telecommunications services which are not taxable in the State to which they would be apportioned pursuant to the apportionment regulation, shall be excluded from the denominator of the sale factor.

Sourcing Receipts from Telecommunications(cont’d.)

New england market based sourcing

Business

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