Indiana Takes Dubious Position on Revenue Sourcing for Online Tuition

August 25, 2017

Indiana ruled that the true income-producing activity was the actual delivery of the course, rather than the development of the class materials, and thus sourced online tuition revenue from Indiana students to Indiana.

When apportioning income among the states where you do business, how should revenue be sourced (i.e., how do you determine if revenue belongs in the numerator and denominator of the sales factor, or just in the denominator)? On July 26, 2017, Indiana issued a Letter of Findings in which it addressed its position on this issue with respect to revenues generated by institutions of higher education that provide online courses. [1]

The facts in these rulings involve three for-profit higher education institutions that deliver online learning courses. These institutions all have physical campuses where classes are held under a traditional learning model both within and outside of Indiana, but their headquarters or main campuses and/or online learning centers were located in Illinois. Alleging to follow Indiana’s “cost of performance” sourcing rules, the taxpayers did not report tuition received from online students located in Indiana as Indiana revenues. Indiana disagreed with this position.

States generally take one of two positions for sourcing revenues from services: market-based sourcing and income-producing activity (i.e., cost of performance) sourcing. Market sourcing seeks to assign sales based on the location of the customer or where the customer receives the benefit of the service. The income-producing activity method assigns sales to the location where the service is performed, typically based on the where the costs of such income-producing activity is performed.

Indiana follows the income-producing activity rule. Sales are assigned entirely to Indiana when either (1) the income-producing activity is performed entirely in Indiana, or (2) the income-producing activity is performed in multiple states and the greatest proportion of the income-producing activity is performed in Indiana, based on the underlying costs of performance. The “income-producing activity” means the acts directly engaged in by the taxpayer for the ultimate purpose of obtaining profit. [2]

Presumably, the income producing activities for a higher education institution selling online learning courses would include the costs involved in actually creating and administering those courses. However, Indiana often takes a narrow approach when identifying the actual income-producing activity and did so here.

In this case, the taxpayers asserted that their revenues should be sourced based on the location where the greater proportion of the class development and production costs were incurred, which was at the locations of their headquarters and/or online learning centers outside of Indiana. Indiana argued that since there is no value in the online courses unless the taxpayers take steps to ensure their students attend them, the actual development and production costs are irrelevant; rather the true income-producing activity is the actual delivery of the service to the students. As a result, the income producing activity is deemed rendered in Indiana when Indiana students attend the online courses.

The outcome here is that Indiana’s interpretation of its income-producing activity sourcing rules give rise to a result that is more consistent with a market-based sourcing approach (i.e., the revenues are sourced based on the location of the student). While it may be inconsistent with what other states could identify as income producing activities, the state makes a somewhat logical, but debatable, argument. Delivery of the service is clearly an act directly engaged in for profit. And while the development of the delivered educational content was a necessary component of these services, it could be considered indirectly related to the event and thus not an income-producing activity. [3]

These rulings and Indiana’s position on revenue sourcing demonstrate the significant challenges facing businesses that engage in multi-state operations. The actual revenue sourcing rules in each state are fairly similar, regardless of which of the two methodologies the state chooses. However, being aware of and understanding each state’s specific interpretations of these rules is extremely difficult.

Nonetheless, that awareness and understanding are crucial to identifying opportunities to minimize state income tax liabilities. For example, if you operated a service business in Indiana that serviced customers outside the state, perhaps you are souring your revenues to Indiana based on the state’s income-producing activity rules. However, could you instead apply the state’s narrow interpretation in this ruling to source your revenues outside of the state, thereby lowering your Indiana income tax liability?

Aprio’s SALT team has experience advising businesses on apportionment and sourcing rules in all states so that you can save money by minimizing your effective state income tax rate. We constantly monitor these and other important state tax issues in order to assist you with your specific tax situation, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at for more information.

This article was featured in the August 2017 SALT Newsletter. You can view the full newsletter here.

[1] DIN: 20170726-IR-045170321NRA, Letters of Findings: 02-20150399; 02-20150400; 02-20150401 Indiana Corporate Income Tax For the Years Ending 6/30/2010, 6/30/2011 and 6/30/2012 (July 26, 2017).

[2] IN Code §6-3-2-2(f); IN Admin. Code 3.1-1-55.

[3] An equally convincing argument could be made that the taxpayers did indeed engage in course development and production directly for the purpose of obtaining profit. However, the holding makes clear that the taxpayers did not attempt to provide support to prove that (1) these activities were direct and (2) the underlying costs exceeded the costs deemed attributable to Indiana.

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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