CO: Market-based sourcing bill passes both houses of legislature

House Bill 1185, which has passed both houses of the Colorado General Assembly, adopts market-based sourcing rules effective for income tax years commending on or after January 1, 2019.

Podcast Overview

Colorado House Bill 1185, which has passed both houses of the Colorado General Assembly, would adopt market-based sourcing rules effective for income tax years commending on or after January 1, 2019. The change, per the bill, is intended to conform Colorado’s income tax laws to the Multistate Tax Compact’s division of income provisions, which were amended a few years ago to adopt definitional changes and market-based sourcing rules for service and intangible receipts. One of these changes to the Compact that will be incorporated into Colorado law with House Bill 1185 is that the term “business income” is replaced with “apportionable income” and the definition is expanded to capture all income that is apportionable under the U.S. Constitution and that is not otherwise allocated under Colorado law. It also includes any income that would be allocable to Colorado under the U.S. Constitution, but that is apportioned rather than allocated under state law. The term “sales” is replaced with “receipts” and “receipts” now means all gross receipts of the taxpayer that are not allocated and are received from transactions and activity in the regular course of the taxpayer’s trade or business. Receipts from hedging transactions and the maturity, redemption, sale, exchange, loan or other disposition of cash or securities are specifically excluded from the definition of “receipts.”

Colorado has long since required corporate taxpayers to apportion their income to the state using a single-sales factor formula. This remains unchanged, although the term “sales” is replaced with “receipts” in the section requiring use of a single-sales factor. In addition, and this is a departure from the Compact’s provisions, House Bill 1185, consistent with current law, provides that notwithstanding any other provision of law, foreign source income that is included in taxable income is not included as receipts of the taxpayer in Colorado for purposes of apportioning income.

Under current law, receipts from sales of other than tangible personal property are sourced using specific rules depending on the type of receipt. Service receipts are sourced to Colorado under the income producing activity test if the revenue from the performance of purely personal services. Other receipts from services are sourced to Colorado if the services are rendered in Colorado. House Bill 1185 provides that receipts from sales other than sales of tangible personal property will be sourced to Colorado if the taxpayer’s market for the sale is in the state. Specific rules determine when a taxpayer’s market for a sale will be considered in Colorado. For example:

  • In the case of a sale of a service, to the extent the service is delivered to a location in Colorado.
  • In the case of a sale, rental, lease, or license of real property, if and to the extent the real property is located in Colorado.
  • In the case of a rental, lease, or license of tangible personal property, if and to the extent the property is located in Colorado.
  • In the case of a rental, lease or license of intangible property, if and to the extent the intangible property is used in Colorado (intangible property utilized in marketing a good or service to a customer is used in Colorado if that good or service is purchased by a Colorado consumer).
  • In the case of a sale of intangible property if and to the extent that the intangible property is used in Colorado (where the property sold is a contract right, government license, or similar intangible property that authorizes the holder to conduct a business activity in a specific geographic area, the intangible property is used in Colorado if the geographic area includes all or a part of Colorado). Receipts from intangible property sales that are contingent on the productivity, use, or disposition of the intangible property are treated as receipts from the rental, lease, or licensing of the intangible property.

Any sale of intangible property not described in the statute is excluded from the numerator and denominator of the receipts factor. Unlike the Multistate Tax Compact, House Bill 1185 does not include a provision throwing out receipts that are assigned to a state where the taxpayer is not taxable. However, House Bill 1185 does provide that if the state or states of assignment cannot be determined under the statutory rules and cannot be reasonably approximated, then the receipts at issue are excluded from the receipts factor entirely.

House Bill 1185 provides extensive rules for allocating nonapportionable rents and royalties from real or tangible personal property, capital gains, interest, dividends, patent or copyright royalties, or other nonapportionable income. Consistent with current law, a taxpayer may elect to treat all income as apportionable income. Once made, this election is irrevocable for the tax year.

House Bill 1185 also addresses alternative apportionment. In addition to its general authority to require use of an alternative apportionment method, the Executive Director may establish appropriate rules for taxpayers engaged in particular industries or that have engaged in particular transactions. These regulations must be applied uniformly. In addition, and in a departure from current law, House Bill 1185 makes clear that the party (the Executive Director or the taxpayer) that seeks to utilize a different apportionment method to effectuate an equitable allocation and apportionment of the taxpayer’s income must prove by a preponderance of the  evidence that the statutory provisions do not fairly represent the extent of the taxpayer’s business activity in Colorado and that the chosen alternative to the statutory provisions is reasonable. If the Executive Director requires use of a different method, it cannot impose civil or criminal penalties with reference to any tax due that is attributable to the taxpayer’s reasonable reliance on the statutory allocation and apportionment provisions. A taxpayer that receives permission to use a different, reasonable method shall not have that permission revoked unless there has been a material change in circumstances or the taxpayer materially mispresented the facts upon which the Executive Director allowed use of the alternative method. If the Executive Director requires a taxpayer to change its method of apportionment, it must notify the taxpayer in writing as to the reasons for the change and provide enough information so that the taxpayer can defend, should it decide to do so, its current method of reporting.

House Bill 1185 retains a current Colorado statute providing that a bank, savings and loan, credit union, or other taxpayer making or purchasing loans whose only business activity in Colorado is the ownership of property acquired  through the process of foreclosure, or was obtained through a procedure exercised in lieu of foreclose, which property is later disposed of within 24 months after obtaining ownership, must directly allocate net income for such property during such time and any  gains or losses realized from the sale of such foreclosed property to the state where the property is located. Please contact Mark Kaye at 303-382-7855 with questions on House Bill 1185.

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