Ohio Court Holds that Taxpayer’s Receipts from Sale of Ohio-Based Contracts are Not Ohio Receipts

Woman monitors dark office

State revenue sourcing rules for services and intangibles often don’t provide clear answers. It’s important to analyze your transactions carefully to ensure that you are not overstating your state apportionment percentage.

By: Jess Johannesen, SALT Senior Manager

The Ohio Supreme Court recently ruled that a taxpayer’s receipts from the sale of Ohio-based customers’ security service contracts with ADT did not constitute Ohio receipts for Ohio Commercial Activity Tax (CAT) purposes.[1]

The taxpayer, Defender Security Company (Defender), was an independent dealer of ADT Security Services (ADT) that advertised and generated leads for new ADT customers, installed equipment at the Ohio properties of those new customers, and signed alarm/security monitoring service contracts with those Ohio customers at the time of installation. ADT ultimately provided security monitoring services to these Ohio customers from six monitoring locations all outside of Ohio. Defender would assign certain contracts to ADT and forward those contracts from its Indianapolis headquarters to ADT’s dealer-support unit in Colorado.[2]

Defender earned several revenue streams from this arrangement: (1) payments from Ohio customers for the cost and installation of alarm equipment, (2) payments from Ohio customers for alarm/security monitoring services under contracts that are not accepted by ADT, and (3) payments from ADT for the purchase of Ohio alarm/security monitoring service contracts assigned from Defender. There is no dispute with respect to the first two revenues streams as Defender treats those as Ohio receipts under the CAT. However, Defender argued that the payments from ADT for the assigned contracts should not constitute Ohio receipts.

The parties agreed that the applicable rule for sourcing these receipts is Ohio’s catch-all provision for receipts not specifically sourced under other provisions, and it states that those receipts “shall be sitused to this state in the proportion that the purchaser’s benefit in this state with respect to what was purchased bears to the purchaser’s benefit everywhere with respect to what was purchased.”[3] In determining that ratio, the statute further provides that “[t]he physical location where the purchaser ultimately uses or receives the benefit of what was purchased shall be paramount in determining the proportion of the benefit in this state to the benefit everywhere.”[4]

However, the parties disagreed on where the “purchaser’s benefit” is. The state’s position is that ADT’s (i.e., the purchaser’s) benefit for Ohio-based customer contracts purchased from Defender is received in Ohio because that is where the properties being monitored by ADT are physically located.

Defender argued that ADT’s physical locations outside Ohio are the places where ADT actually used and received the benefit of the assigned contractual rights. The Court agreed with Defender noting that the benefit Ohio customers received from ADT should be distinguished from the benefit that ADT received by purchasing customer contracts from Defender.

The Court explained that ADT’s customers acquire the benefit of ADT’s security services at their Ohio properties that are being monitored, and as such, the customers’ payments for those services constitute Ohio receipts.

By contrast, ADT purchased intangible contractual rights from Defender, and the benefit of such purchases was ADT’s right to receive payments from Ohio customers in consideration for the contracted-for monitoring services. The physical location at which ADT uses and receives the benefit of its purchased contracts are ADT’s physical locations where it receives customer payments and performs services for Ohio customers, all of which are outside Ohio.

This ruling highlights that the application of Ohio’s market-based sourcing methodology for receipts from the sale of a contract right does not necessarily equate to the location where the benefit is received by the customer to whom the service is performed under that contract. Aprio’s SALT team has experience researching and analyzing these complex state sourcing issues, and we can assist your business by reviewing your revenue streams and apportionment sourcing to make sure that you minimize your state income tax liabilities. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Jess Johannesen, SALT Manager at Jess.Johannesen@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the November/December 2020 SALT Newsletter.

[1] Defender Security Company v. McClain, Slip Opinion No. 2020-Ohio-4594, 09/29/2020.

[2] In 5% – 6% of instances, ADT rejects assignment of the security monitoring contract generated by Defender, and in such instances the customers pay Defender for security-monitoring services provided by ADT.

[3] Ohio Rev. Code Ann. § 5751.033(I)

[4] Id.

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