South Carolina Court Upholds Narrow Approach to Revenue Sourcing

September 27, 2017

South Carolina’s application of its income-producing activity sourcing rules gave a market sourcing result, where services were sourced to the customer location.

For state income tax apportionment purposes, states generally utilize one of two methods for sourcing revenues from services under the sales factor: market-based sourcing or income-producing activity 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 where the costs of such income-producing activity is performed.

South Carolina sources receipts from services based on an income-producing activity rule whereby receipts from services are assigned to South Carolina to the extent the income-producing activity is performed within the state. [1] “Income-producing activity” is not defined in the tax statute or regulations. Last month, the South Carolina Court of Appeals issued a decision narrowly interpreting “income-producing activity” to assign to the state all of DIRECTV’s subscriber revenues from South Carolina subscribers. [2]

In this case, DIRECTV, based in California, asserted that its income-producing activities are the company’s value-driving business operations that influence customers’ decisions to subscribe to its services and thus contribute to the generation of the receipts, such as content development, marketing, broadcast operations and customer service. DIRECTV argued these subscription revenues should be sourced based on the location where its employees perform these activities (i.e., almost entirely outside South Carolina).

The Court of Appeals disagreed with DIRECTV and instead concluded, consistent with the state’s argument, that the company’s income-producing activity was limited to the delivery of its programming signal. The purchase of DIRECTV’s services and the delivery of television services in the customers’ homes were the activities that actually generated the income, not the activities that indirectly contributed to a customer’s decision to purchase the service. Therefore, the Court explained, DIRECTV’s content development, marketing and broadcast-related activities were not actually income-producing activities since they were performed in anticipation of future profits and did not actually produce income.

South Carolina’s application of its income-producing activity sourcing rules gave a market sourcing result, in that the services are sourced to the customer location. [3] While it may be inconsistent with what many other states identify as income-producing activities, in that the approach does not take into account activities which are likely necessary but only indirectly contribute to the generation of receipts, South Carolina is not the only state to apply a very narrow definition of income-producing activity. [4]

This ruling and South Carolina’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 operate a service business in South Carolina that services customers outside the state, perhaps you are sourcing your revenues to South Carolina based on a broad approach to 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 South Carolina 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 September 2017 SALT Newsletter. You can view the full newsletter here.

[1] SC Code Ann. §12-6-2295(A)(5).

[2] DIRECTV v. South Carolina Department of Revenue, Appellate Case No. 2015-001509 (S.C. Ct. of App. Aug. 30, 2017).

[3] Many states have special apportionment and sourcing rules for cable and satellite television companies that specifically source revenue based on the location of the audience or subscribers.

[4] See our August 2017 SALT Newsletter article explaining a recent ruling in Indiana, in which online tuition revenue received by an Illinois-based educational institution from Indiana customers is sourced to Indiana under the income-producing activity rule. The state determined that the income-producing activity was just the delivery of the service to the Indiana customer and not the Illinois-based activities dealing with course development and production (e.g., lectures, materials, etc.).

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.