Welcome to TWIST for the week of December 5, 2022, featuring Sarah McGahan from the KPMG Washington National Tax state and local tax practice.
First up today, the California Department of Tax and Fee Administration has proposed several clarifying amendments to the California regulation addressing marketplace sales.
In Florida, a circuit court recently ruled in a taxpayer’s favor in a dispute over the proper sourcing of a taxpayer’s service receipts. As background, under a Florida rule, service receipts are generally sourced to Florida if a greater proportion of the income-producing activity is performed in Florida, based on costs of performance. In the past, the Department has applied this test to result in market-based sourcing. After an audit, the Department asserted that the taxpayer did not provide sufficient evidence to support its costs of performance method and therefore the Department was allowed to apply an alternative formula based on retail square footage of the taxpayer’s parent in Florida over its retail square footage across the country. The circuit court rejected the Department’s position that the taxpayer had not provided sufficient information. The taxpayer had given the auditor state-by-state payroll, property, and sales apportionment workpapers and the workpapers made clear that the overwhelming proportion of the taxpayer’s payroll costs were incurred outside Florida. Because most of the taxpayer’s payroll was outside Florida, the court concluded that none of the receipts from the sale of the services at issue should be considered Florida sales.
In Ohio, the state Supreme Court recently overturned a Board of Tax Appeals determination holding that certain receipts related to the use of intellectual property should be sitused to Ohio for CAT purposes. Under the CAT law, gross receipts derived from a grant of the right to use intellectual property are sitused to Ohio to the extent the receipts are based on the right to use the property in Ohio. Although the receipts at issue were payments for the right to use intellectual property, none of the taxpayer’s contracts tied the payment of the fees to a specific right to use the licensed intellectual property in Ohio. As such, the court concluded that the fees were not “based on the right” to use the property in the state and were not sitused to Ohio.
Finally, the Tennessee Department of Revenue recently issued two rulings addressing whether taxpayers were providing nontaxable services or taxable computer software. In one of the rulings, the Department determined the true object of the transactions were for customers to obtain nontaxable information and data processing services. In contrast, in the other ruling, the Department determined that the taxpayer was selling computer software, rather than providing nontaxable advertising services.
The California Department of Tax and Fee Administration has proposed amendments to CCR section 1684.5, which addresses marketplace sales. Under California law, on and after October 1, 2019, a marketplace facilitator is a retailer engaged in business in the state if its total combined sales (i.e., including both sales of its own property and sales it facilitates on behalf of marketplace sellers) of tangible personal property for delivery into California exceed $500,000. Similarly, a marketplace seller must include both direct sales and marketplace facilitated sales in determining whether it exceeds the economic nexus threshold. One amendment to the regulation would confirm that a marketplace facilitator and a marketplace seller must include both taxable and nontaxable sales in determining whether it exceeds the $500,000 threshold. Another amendment would clarify that to be considered a “marketplace” a physical or electronic place must offer tangible personal property for sale by multiple marketplace sellers. As such, a company that sells web hosting services and related services (e.g., payment processing) to other sellers who use the services to create their own e-commerce websites would not be considered a marketplace facilitator. The revised regulation also makes clear that a person is not required to provide payment processing services to be considered a marketplace facilitator.
Another set of amendments to the regulation addresses the statutory carve out for websites that are merely advertising tangible personal property for sale and refer a purchaser to the seller to complete the sale. Under California law, such entities are not considered to be facilitating a sale. The amended regulation adopts a new subsection to address “advertising” to clarify that when the advertising exclusion applies to a sale, the person publishing the advertisement is not considered the seller and retailer for the sale and that such person is not the retailer selling or making the sale of the tangible personal property sold through the advertisement. This is true regardless of whether the person is a marketplace facilitator, the seller is a marketplace seller, the tangible personal property is advertised in a marketplace, or the advertisement contains an offer to sell tangible personal property. One of the new examples in the “advertising” section confirms that when a person takes orders for sellers that advertise goods on the person’s website, that person is facilitating the sale of tangible personal property and would be considered the retailer for those sales. “Order taking” would be newly defined to mean the process of getting or obtaining a buyer’s order to buy a marketplace seller’s tangible personal property by telephone, fax, email or any other physical or electronic means, including, but not limited to, the customer including the items in a physical or virtual shopping cart at checkout. Please contact Jim Kuhl with questions on California’s marketplace facilitator rules.
On November 28, 2022, a Florida circuit court ruled in a taxpayer’s favor in a dispute over the proper sourcing of a taxpayer’s service receipts. As background, Florida’s tax statutes are silent with respect to sourcing sales of other than tangible personal property. Under Fla. Admin. Code Ann. 12C-1.0155(2)(l), “other” receipts are sourced to Florida if the income-producing activity giving rise to the receipts is performed wholly within Florida or if a greater proportion of the income-producing activity is performed in Florida, based on the costs of performance (IPA/COP rule). Despite the rule, the Department of Revenue has indicated in its guidance and rather consistently taken the position that Florida is a market-based sourcing state and has cited favorably to guidance from other states that sourced the “income-producing activity” for a particular taxpayer to where the benefit is received or where the customer or purchaser is located.
The taxpayer at issue was a Minnesota-based subsidiary of a large, multistate retailer. The taxpayer earned revenue by providing merchandising, marketing, and management consulting and advisory services to the retailer and others in exchange for compensation. After an audit, the Department asserted that the taxpayer’s service receipts should be attributed to Florida based on a numerator that was the retail square footage of the retail stores of the taxpayer’s parent corporation in Florida and the denominator of which was the retail square footage of all the parent corporation’s retail stores across the country. As support for this adjustment, the Department relied on Fla. Stat. §220.44, which permits the Department to make adjustments to a taxpayer’s income—including adjustments to any factor taken into account to apportion income—to clearly reflect business activity in the state. The taxpayer protested the adjustment, noting that the Department’s regulation attributed these receipts to the location of the income-producing activity engaged in by the taxpayer, which was determined based on the location that the costs to perform the services were incurred. In the taxpayer’s view, the location of the costs to perform its services occurred at its Minnesota headquarters where the large majority of its employees were located. The dispute was not resolved, and matter eventually came before a circuit court.
The circuit court noted at the outset that the issue of how the receipts should be sourced was governed by the IPA/COP rule that looked to the location where the costs to perform the relevant services were incurred. Under this all-or-nothing rule, if the greater proportion of those costs were incurred outside Florida, the taxpayer would have no sales attributable to Florida and have a zero Florida sales factor. The Department’s position at trial was that the taxpayer failed to provide sufficient documentation to support the use of the IPA/COP rule, which meant it was entitled to adjust the apportionment factor under Fla. Stat. §220.44. The court rejected this position. The taxpayer had provided state-by-state payroll, property, and sales apportionment workpapers to the auditor. The workpapers made clear that the overwhelming proportion of the taxpayer’s payroll costs were incurred outside Florida; therefore, the court concluded that none of the receipts from the sale of services should be considered Florida sales. Further, the court did not find that the Department had any reason to apply an alternative apportionment method, as the taxpayer had provided sufficient documentation to support its costs of performance approach.
The court further noted that even if the Department could apply an alternative method, the proposed method (square footage of its parent corporation’s retail stores) had no relevant relationship to the taxpayer’s business activity in the state of Florida. Importantly, the taxpayer was not providing these services directly to the retail locations; rather, the services were provided to the parent corporation at its Minnesota headquarters. The court concluded that the Department’s proposed formula conflated the parent corporation’s Florida business activity with the taxpayer’s business activity and would therefore be rejected.
It remains to be seen whether the state will appeal the decision. As noted above, the Department of Revenue has in the past interpreted the income-producing activity test in a manner that resulted in a customer-based or market approach for sourcing service receipts.1 It appears (based on the written opinion) that the Department’s position in this case focused primarily on whether the taxpayer’s evidence was insufficient so that an alternative apportionment method was allowed, as opposed to any particular interpretation of the income-producing activity test. However, taxpayers—particularly those that have utilized a market-based method for Florida purposes— should consider potential corporate income tax refund opportunities as a result of this decision. Despite the outcome of this recent decision, we anticipate the Department may remain focused on its previous customer-based approach to identifying income-producing activities, and taxpayers should be prepared to document and defend their sourcing analysis for audit and refund negotiation purposes. Please contact Jeremy Dukes or Henry Parcinski to discuss Target Enterprise, Inc. vs. State of Florida Dep’t of Revenue.
1See e.g., Technical Assistance Advisement No. 20C1-001 (Jan. 13, 2020); Technical Assistance Advisement 20C1-010 (Sept. 11, 2020).
The Supreme Court of Ohio recently overturned a Board of Tax Appeals determination holding that certain receipts related to the use of intellectual property should be sitused to Ohio for CAT purposes. The taxpayer at issue was the reporting member of a combined group that included the National Association for Stock Car Auto Racing (NASCAR), which held NASCAR-sanctioned events in Ohio and broadcast races in all fifty states, as well as other countries. NASCAR did not file CAT returns for the tax years at issue and was subsequently audited. On audit, the Commissioner sitused NASCAR’s broadcast and media revenue to Ohio based on the number of cable television households in Ohio as a proxy for the Ohio audience of the programs. Revenues from license fees and sponsor fees related to the events were sitused to Ohio based U.S. Census population data, applying the percentage of population in Ohio as compared to the national population. Other fees—sanction fees, membership revenue, and competition revenue— were sitused based on the location of the race event for which they were paid. NASCAR protested the Commissioner’s adjustments, arguing that nearly all its relevant revenue should be sitused to its headquarters in Florida where it received the benefit of its agreements with the purchasers of the intellectual property rights. After the Board upheld the Commissioner’s assessment, NASCAR directly appealed to the Ohio Supreme Court.
Before the high court, the key issue was whether the taxpayer’s broadcasting, media, licensing and sponsorship receipts were sitused to Ohio. Under Ohio law, gross receipts from the sale, exchange, disposition, or other grant of the right to use trademarks, trade names, patents, copyrights, and similar intellectual property are sitused to Ohio to the extent that the receipts are based on the amount of use of the property in Ohio. There is an alternative catch-all situsing provision that applies to other receipts. The Commissioner had originally relied on the catch-all provision to source NASCAR’s receipts, but the Board determined the statute addressing gross receipts from licensing intellectual property was the proper situsing statute and that the outcome (i.e., that the receipts should be sourced based on number of cable TV households and population) was the same regardless. The Ohio Supreme Court first addressed and dismissed as a “nonstarter” the taxpayer’s argument that it was improper for the Board to affirm an assessment of tax on a statute that differed from that under which the Commissioner had made the original determination. The court then moved on to the taxpayer’s substantive challenges to the assessment. The statute at issue permitted taxation of gross receipts derived from a grant of the right to use intellectual property only “to the extent the receipts are based on the right to use the property in this state.” Although the receipts at issue were payments for the right to use intellectual property, none of NASCAR's contracts tied the payment of the fees to a specific right to use the licensed intellectual property in Ohio. As such, the court concluded that the fees were not “based on the right” to use the property in the state. The Commissioner's position that he could approximate what share of the nationwide rights should have been attributable to the use of the intellectual property in Ohio was rejected as being beyond the scope of his statutory authority. As a result, the court concluded that the assessments related to NASCAR's broadcast revenue, media revenue, licensing fees and sponsorship fees were invalid under the statute. Having agreed with NASCAR's statutory argument, the court declined to address additional constitutional arguments relating to the dormant Commerce Clause.
In a partial dissent, three justices asserted that NASCAR's licensing fees should have been analyzed under the provision for actual use of intellectual property (instead of the provision concerning the right to use such property) and that the assessments related to licensing fees should have been upheld on those grounds. The majority, however, pointed to the clear statement by the Commissioner that his assessment relating to licensing fees had been calculated under the right-to-use standard and chose to “steer clear of new theories for taxability that were neither relied on by the tax commissioner nor argued by the parties.” Please contact Dave Perry with questions on NASCAR Holdings, Inc. v. McCain, Slip Opinion No. 2022 Ohio-4131.
The Tennessee Department of Revenue recently issued two rulings addressing whether taxpayers were providing nontaxable services or taxable computer software. Under Tennessee law, computer software, including remotely accessed computer software, is subject to sales and use tax. The taxpayer in Letter Ruling #22-07 provided a subscription-based product for creating and managing advertising. The product was used to produce advertisements, which were then deployed to other platforms. The product then consolidated data related to the advertisements on a user's dashboard. The taxpayer suggested that while its product may involve access to and use of computer software, those components were ancillary to its primary function, which was the provision of nontaxable advertising services. The Department disagreed, determining that the taxpayer was providing software that facilitated the creation and management of a user’s own advertising. The product- software- was being used for its functionality, and a customer was not purchasing an advertising service. The Department noted that the taxpayer had compared its situation to the facts in Letter Ruling #19-01; however, the customers in Letter Ruling #19-01 used the taxpayer's product to create event listings later published on the taxpayer's platform. In that instance, the Department concluded that the true object was the nontaxable platform and listing services.
Letter Ruling #22-08 addressed a taxpayer that provided compliance monitoring services using its own proprietary data set. The data set was consistently verified, enhanced, and updated. The scope and extent of each of the taxpayer’s four service offerings varied slightly, but generally each service allowed customers to monitor certain information (for example, on a customer’s employees or vendors) against the taxpayer’s proprietary data set. The customers accessed the services either through the Taxpayer’s online portal or through an API. Although the Department noted that the API could broadly be seen as taxable computer software, it applied the true object test and concluded that the use of the online portal or API was merely incidental to providing nontaxable information and data processing services. The ruling noted that there was no additional charge for the API, and that the online portal and the API were being used only to gain access to the nontaxable services. Please contact Justin Stringfield with questions.