Connecticut sourcing guidance for companies in the finance industry
Historically, some entities in the financial service industry could not utilize Connecticut’s “financial service company” (FSC) apportionment because the entity was either subject to the state income tax, or the entity did not meet the definition of an FSC under the corporate business tax. With recent legislation and guidance from the Connecticut Department of Revenue Services (DRS), those rules no longer apply. The DRS issued Special Notice 2017-1, on April 17, 2017, providing that entities involved in financial service-related industries should utilize the sourcing methodology enacted for statutory “financial service companies.”
Before Special Notice 2017-1, corporations qualifying as an FSC under the corporation business tax were the sole beneficiaries of 1) the right to apportion, 2) single-sales factor apportionment, and 3) specialized industry apportionment similar to market-based sourcing. These specialized rules created a potentially significant discrepancy in tax treatment for businesses that derived financial-service receipts and were neither formed as corporations nor qualifying under the statutory definition of FSC.
Businesses providing financial services subject to the income tax were forced to apply a three-factor apportionment methodology and Connecticut’s “sales office rule” for purposes of sourcing receipts. The sales office rule was similar to, but not directly in-line with, an income-producing activity or cost-of-performance methodology. Additionally, corporations which did not qualify as an FSC under the statutory criteria, but provided similar financial services, applied a three-factor double-weighted apportionment methodology, with cost of performance sourcing, or applied to the Commissioner of the DRS for an alternative apportionment methodology.
The potential discrepancy in treatment between FSCs and entities in the financial industry was partially negated with Connecticut’s adoption of single-sales factor apportionment and market-based sourcing under the corporation business tax for periods beginning on Jan. 1, 2016, along with the analogous treatment extending to the income tax for periods beginning on Jan. 1, 2017.
With the new guidance established by Special Notice 2017-1, the DRS has achieved a degree of equity for corporations which did not qualify as an FSC for purposes of the corporation business tax, or entities subject to the income tax, to apply the rules previously reserved for qualifying FSCs under Connecticut General Statute Section 12-218b for purposes of sourcing receipts. The guidance establishes a position that Connecticut-based practitioners have long sought from the DRS and provides more equal treatment amongst taxpayers regardless of entity choice.