Washington Finds that ATM Processor’s Service Revenue Sourced to ATM Location for B&O Tax
For apportionment purposes, applying market-based souring rules to service revenues is complicated because it is based on the facts and circumstances of each transaction.
Over the past several years, many states have moved from the cost-of-performance method of apportioning service revenues to the market-based approach. A number of those states have provided specific guidance on how to determine “the market” for a particular item of revenue. However, applying those rules does involve making certain judgments, about which states and taxpayers may not always agree. On Oct. 31, 2018, the Washington Department of Revenue Appeals Division (the “Division”) released a Tax Determination regarding the application of the states sourcing rules for ATM processing fees under the state’s Business & Occupation (“B&O”) Tax.
The Taxpayer, an out-of-state company, processes ATM transactions. The ATM card process transaction consists of an ATM cardholder swiping his/her ATM card in the ATM machine in order to withdraw cash. The Acquirer (i.e., the company who owns the physical ATM machine) then requests authorization for the transaction from the Issuer (i.e., the financial institution that issued the cardholder’s debit card) electronically through the Taxpayer’s system. The Taxpayer’s system processes the information, routing it to the Issuer for authorization of the pending ATM card transaction. The Issuer then authorizes/denies the transaction based on the information received. The Taxpayer’s system processes the authorization decision and routes it to the Acquirer who then transmits the decision to the cardholder via the ATM machine. If the Issuer authorized the transaction, the ATM machine issues the cardholder cash. This entire process is generally completed in a few seconds. If the transaction was authorized, the Taxpayer also facilitates a clearing and settlement of the ATM transaction between both the Authorizer and Issuer.
The Taxpayer receives revenues through two sources: card service fees and data processing fees. The card service fees are received from the Taxpayer’s customers who pay such fees for membership agreements in order to access the transaction processing system. Some members also receive the privilege of issuing ATM cards to individual cardholders bearing the Taxpayer’s brand mark. The card service fees were calculated as a percentage of the total monetary amount of purchase charged on the ATM cards. The second source of revenue, data processing fees, are paid by both Issuers and Acquirers for using the Taxpayer’s system for transactions, as described above, and were calculated based on the total number of ATM card transactions processed by the Taxpayer.
Taxpayer filed and paid Washington B&O Tax under the “Services & Other Activities” classification and apportioned its gross income to Washington based on the billing address of the Issuers and Acquirers. When the Taxpayer was audited by Washington Department of Revenue (“DOR”) for the period of June 2010 – December 2012, the state issued a deficiency assessment on the grounds that the Taxpayer should be sourcing its income based on the location of the ATM machines and not the Issuer’s and Acquirer’s billing addresses. The Taxpayer appealed the findings.
Under the services and other activities classification, gross income is apportioned using a receipts factor, the numerator of which is gross income from Washington sources, and the denominator of which is total gross income. Under the state’s rules, the determination of gross income from Washington sources is made via a cascading hierarchy of rules, which a taxpayer applies in order, only moving to the next one in line if it can’t apply the current rule.
The first sourcing rule is where the customer receives the benefit of the service, and that rule is applied by the taxpayer if it can reasonably determine that location for a specific item of revenue. If a customer receives the benefit of the taxpayer’s services in Washington and one or more other states, and if the amount of gross income earned by the taxpayer in return for the services received by the customer in Washington can be determined by applying a reasonable method of proportionately attributing the benefit among states, then such proportionate amount of gross income is attributed to Washington. For purposes of applying the benefit of the service rule, if the service (i) does not relate to real or tangible personal property, (ii) is provided to a customer engaged in business, and (iii) the relates to the customer’s business activities, then the benefit is received where the customer’s related business activities occur.
The third sourcing rule is based on where the taxpayer sends the billing states to the customer. Therefore, in order for the taxpayer to be able to use the third rule, it must show that it is unable to apply the first rule because there is no reasonable method to proportionately attribute its gross income.
Ultimately, the Division concluded that the DOR’s method of attributing the benefit of the service to the location where the “swipe” of the ATM card occurs is a reasonable method. The Division looked to the related business activities of the Acquirers (i.e., completing the ATM transaction through its ATM machines) and Issuers (i.e., the authorization of ATM card cash withdrawals and the related debiting of the cardholders’ checking accounts for such withdrawals), and found that such related business activities occur at the ATM location. The Division stated, “That “swipe” location is the location of the ATM machine . . . where the individual cardholder is using the Issuer’s authorization of cash withdrawal, and is also the location at which the Acquirer completes the ATM card transaction on its ATM machine.”
As this ruling Demonstrates, application of market-based sourcing rules and determining where the customer receives the benefit of a service is not a straight forward analysis. Businesses must consider these rules carefully and understand the guidance that is being issued. Aprio’s SALT team has experience with multi-state apportionment issues and can advise companies on applying market-based sourcing rules in a manner that minimizes tax obligations while at the same time reducing the likelihood that the state will be successful in challenging that position. 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.
This article was featured in the November/December 2018 SALT Newsletter.
 Washington Tax Determination No. 16-0026, 31 WTD 201 (October 31, 2018).
 Rev. Code. Wash. § 82.04.062 and Wash. Admin. Code § 458-20-19402.
 There are 6 sourcing rules in the hierarchy, but rules 2, 4, 5, and 6 are not at issue in this case.
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.