I recently joined a conference call with the Multistate Tax Commission who oversees the regulation of state corporate income tax, which includes provisions on how to recognize taxable business income in a state. The call was for designated members by state to vote on current amendments to an important provision – UDITPA (Uniform Division of Income for Tax Purposes), Article IV, Section 17 - specifically to change the method of sourcing intangible sales; to re-define business income to include ‘constitutionally apportioned’ income which also expounds on intangible property sales; and lastly to rename sales as receipts which I’m assuming will soften the tangible aspect of defining a transaction? Or could it be a way to distinguish sales taxable sales from income taxable sales, to simplify identification for tax purposes? The actual goal, according to the commission, is to reflect changes to the transactional and functional test requirements when considering taxable income but, either way, of course the amendments passed quickly and with flying colors…..Why?
This is an attempt by the commission to fill the void of states difficulty to make claim to service receipts (formerly known as sales) - particularly those earned by out-of-state companies to their instate consumers - by putting some parameters around transactions that don’t have a physical link to a state; metaphorically forming walls around a sale just enough to establish substantial nexus. The amendments are described as follows:
Sourcing Change from Cost of Performance to Market Based
For transactions other than sales of tangible property, the provision has been changed from sourcing service revenue/other intangible receipts based on cost of performance, which designates the transaction to the state where cost originates, to the market-sourcing approach which designates such revenue to states where the consumer will ultimately benefit from the use of such services or intangible property.
Change in Definitions of Business Income and Sales
Business income is now defined as apportionable income, to recognize any income generated from transactions and activity in the regular course of trade or business as income that can, under the Constitution of the United States, be legally assigned (apportioned) to a state; and income arising from tangible and intangible property if acquisition, management, employment, development or disposition of the property is or was related to the operation of the taxpayer’s trade or business.
The definition of sales has been upgraded to emphasize the inclusion of revenue received from transactions and activity in the regular course of the taxpayer’s trade or business as well. Thus reforming the name from sales to receipts.
Both changes have been made to establish the intent on how states will impose tax filing requirements based on the transaction activity that generated the apportionable income, more so than the physical presence attached to the transaction.
It’s Like Déjà vu….
When I read the amendments, and their over emphasis of ‘apportionable income under the Constitution of the United States’, I’m reminded of the original issues that gave rise to this regulation when the threat by Congress to restrict states’ right to tax arose. The UDITPA provision was born out of the need for states to come up with a uniform way of taxing businesses that are non-discriminatory, yet fair in the state’s right to tax. Although it has been amended several times (last amendment was in 1971), a new era has dawned in the world of e-commerce where the argument for why a state should claim jurisdiction on who and what to tax - no matter where the sale or service originated - need to be justified. Since the Supreme Court has been reluctant to even hear cases on this matter, this particular conference call seems reminiscent of what may have urged the commission to provide a resolution to their tax jurisdiction problem in the 1950s; to provide a remedy so Congress would stay at bay. The question now is, will this be enough to appease tax lawmakers this time to not expand restrictions on state taxable income, or do they even care to rule on the subject at all?
Who will immediately become vulnerable to these changes?
If you are an out-of-state business who sell, rent or license intangible products or services online, you may need to re-evaluate your business activities to determine any potential tax responsibilities in the future. If you are a company who base your state tax planning around the cost of performance sourcing strategy, there’s a high probability that tax provision adjustments will be needed.
Melinda has practiced multistate tax compliance and consulting for ten years. Her experience includes working at Big 4 and regional firms where she engaged in multiple state tax compliance and planning projects for fortune 500 companies. She also worked in industry where she was instrumental in restructuring the tax department to implement state income tax processes and procedures. As a sole practitioner, she helps multi-national corporate clients with compliance responsibilities, perform nexus studies to determine tax exposure, provide tax resolution services to clients who need help to restore good standing with state and local tax agencies, and help companies reduce their tax liability through proactive tax reduction strategies and planning.
To determine the best solutions for your tax situation. Please call to schedule a consultation with M.S. Phelps, CPA, PLLC - 313.757.1440.