Multistate Tax Commission Releases Working Draft of Model Market-Sourcing Regulations: Part I
The Multistate Tax Commission has released a draft of market-sourcing regulations that provides guidance on the sourcing of receipts from in-person, professional and other services.
By Tina Chunn, SALT senior manager
As the economy continues to shift to a service environment, states have increasingly begun to adopt alternative apportionment methodologies for income tax purposes to more accurately reflect the income derived from the states. One of the more popular trends is market-based sourcing of revenue from sales other than those of tangible personal property for sales factor purposes, which assigns such sales revenue based on the “market.” This sourcing methodology replaces the cost of performance approach that those states had historically used, whereby service revenue was typically sourced to the state where most of the service was performed.
Although the states adopting this methodology are enacting similar guidelines, there is still much confusion in this area due to the fact that (1) states are sometimes using different concepts to define the “market,” such as “where the benefit of the service is received,” “where the service is delivered” or “where the customer is located,” and (2) applying any of these market definitions is often difficult for services and is open to many interpretations. In response to these issues, the Multistate Tax Commission (MTC) formed a working group to draft a model regulation for market-based sourcing. This group released a working draft of these regulations in July 2015.
These guidelines address receipts from many different types of transactions, including services and intangibles. Given the changes that many states are making with regards to sourcing of receipts from the sale of services, we will focus our attention on the guidance for these particular receipts. In general, these rules provide that the revenue from sales of services is sourced to a state “if and to the extent the service is delivered to a location in this state.” The regulations provide guidance and clarification on where a service is delivered. As you may have guessed, determining where the service is delivered is not a simple task and is open to interpretation. Specifically, these model rules provide guidelines on determining where the service is delivered for three specific types of service transactions: (1) in-person services, (2) professional services and (3) other services. This newsletter addresses (1) and (2); our September 2015 newsletter will address (3).
In-Person Services: These are services that are physically provided in person by the taxpayer and include services on real or tangible personal property provided at the same location as the customer’s property. Examples include the following services: warranty and repair, cleaning, pest control, medical and dental, hair cutting and salon, child care, live entertainment and in-person training. Professional services (e.g. legal or accounting services) are not included as in-person services for purposes of this section.
These services be considered delivered at the location where the service is received (which is generally going to be where the service is performed). If the service is performed on property that is shipped to a customer, it is considered received in the state where the property is shipped or delivered to the customer, regardless of whether the service is performed in the same state.
Professional Services: These are services that require specialized knowledge or a professional certification, license or degree. (e.g., bank and financial services, tax preparation, legal services and graphic design services).
The regulations note that due to the differences in the types of professional services, there isn’t one general rule to determine where such services are delivered, and thus it must be reasonably approximated. This will depend on whether the sale is to an individual or business customer. For individual customers, sales are generally assigned to the customer’s primary residence (or billing address if primary residence is not reasonably identifiable). For business customers, services receipts are assigned based on the following hierarchy: first to the state where the contract is managed by the customer, second to the customer’s place of order (if the location where the contract is managed can’t be reasonably determined) or third to the customer’s billing address (if the customer’s place of order can’t be reasonably determined). If services are performed in relation to real or tangible personal property (e.g. architectural or engineering services), then the receipts are assigned based on the location of the real or tangible personal property or an approximate location based on sufficient information.
Until more uniform guidelines such as those being drafted by the MTC are finalized and adopted by the states, the result of the varying market-based sourcing rules is that it will be increasingly difficult for taxpayers to make sourcing determinations for service revenue. Even if all the states eventually adopted this model, they may not interpret these guidelines in the same manner, especially in instances where the guidance does not clearly apply to the particular service offering or there is insufficient information to make a sourcing determination. Understandably, this uncertainty creates frustration for taxpayers, but it also provides an opportunity for companies to review the governing guidance and how it would apply to their specific service revenues, and perhaps determine a more favorable sourcing methodology.
HA&W’s SALT team is able to provide guidance in uncertain tax areas such as this and assist in any analysis that may be necessary. We constantly strive to keep our clients advised of these important issues in order to help them address their specific tax situations. We will continue to monitor these and other significant income tax developments and include any updates in future issues of the HA&W SALT Newsletter.
Contact Tina Chunn, SALT senior manager, at firstname.lastname@example.org or Jeff Glickman, partner-in-charge of HA&W’s SALT practice, at email@example.com for more information.
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 this matter.