Tax Court Rejects Indiana’s Narrow Interpretation of Revenue Sourcing Rules

February 2, 2018

The Tax Court determined that an online university’s actual income-producing activities took place outside the state and thus should not be sourced to Indiana.

In our August 2017 SALT Newsletter, Aprio reported on a tax department policy decision in Indiana where the state took a questionable position on its income tax revenue sourcing rules. For corporate income tax apportionment purposes, Indiana follows “cost-of-performance” sourcing rules, where revenues from services are assigned to the state based on the location where the underlying costs of the income-producing activities are incurred. However, in the example of three educational institutions that were providing online learning courses, the Indiana Department of Revenue sought to take a narrow approach to this law, resulting in revenues sourced based on the location of the customer.

The University of Phoenix (“the University”), which had its assessment protest denied in 2014, filed an appeal to the Indiana Tax Court. A trial was held in early 2017, and on Nov. 30, 2017, the Tax Court issued an opinion ruling against the Indiana Department of Revenue and in favor of the University in this matter. [1]

Under Indiana law, 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]

The University initially sourced their revenues under these principles. They identified the income-producing activities with respect to online learning revenues as (1) operation of the online campus platform, (2) classroom instruction, (3) curriculum development and (4) the activities of the “graduation team,” which include enrollment advice, academic counseling and student financing. The University contended that these four activities were the indispensable acts that led to the production of online learning income from Indiana students. Certain activities and costs that were not directly related to students attending the online learning classes, such as informational technology and training, were not considered to be income-producing activities and excluded from this analysis. Since very little of the costs were incurred in Indiana and the greatest proportion of the income-producing activities occurred outside of the state, none of the University’s receipts (i.e., tuition) from online learning were sourced to Indiana.

Under audit, the Department of Revenue adjusted the University’s receipts to include all online learning receipts from students located in Indiana. On its surface, this appears to be a “market” sourcing method to assigning receipts rather than the “income-producing activity” method dictated by state law. However, the Department asserted that this was appropriate on the grounds that the sole income-producing activity was simply providing the opportunity to attend an online class in return for payment and the Indiana resident agreeing to do so, with the assumption that these activities occurred within Indiana.

The Indiana Tax Court rejected the Department of Revenue’s reasoning. The Department’s approach to identifying the income-producing activities was derived from the student’s/customer’s perspective, in that it only considered the activities that provide a student the opportunity to attend an online class. The Tax Court contended that the income-producing activities should be viewed from the perspective of the seller given that “income-producing activity” is defined as the acts engaged in by the taxpayer/seller. Accordingly, one cannot narrowly view its income-producing activities as those actions solely related to receipt of service, but must consider all the acts a seller engages in directly for the purpose of generating the income. The result of this ruling is that taxpayers should be able to consider all of their income-producing activities that directly result in the production of income in Indiana.

It’s worth noting that the Indiana Department of Revenue made a point in support of its position that, while not actually applicable to Indiana, provides support for other states to follow a similar approach. The Department argued that the University’s identification of its income-producing activities was unreliable in that it was based on an aggregate or operational approach rather than viewing the activities on a transaction-by-transaction basis. Indiana’s law and regulations do not specify that a transaction-by-transaction approach be used; however, several other states do. If one were to view the underlying costs of the income-producing activities for each separately identifiable item of income on a transaction-by-transaction basis, it’s possible that certain items of revenue would be sourced differently.

This ruling shows some of the significant difficulties facing businesses that engage in multi-state operations. The actual revenue sourcing rules in each state may be fairly similar, regardless of which of the methodology a state chooses. However, being aware of and understanding each state’s specific interpretations of these rules is particularly challenging. Nonetheless, that awareness and understanding are crucial to identifying opportunities to minimize state income tax liabilities.

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 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 January 2018 SALT Newsletter.

[1] The University of Phoenix, Inc., v. Indiana Department of State Revenue, Indiana Tax Court Case No. 49T10-1411-TA-00065 (Nov. 30, 2017). While this Tax Court opinion does not involve the taxpayers that were the subject of the Letter of Findings discussed in our August 2017 article, the opinion essentially overturns that administrative ruling since it involved the exact same issue.

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

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.

Stay informed with Aprio.

Get industry news and leading insights delivered straight to your inbox.

Stay informed with Aprio. Subscribe now.