Pennsylvania Department of Revenue issues sales factor sourcing guidance
TAX ALERT |
On Dec. 12, 2014, the Pennsylvania Department of Revenue (the Department) finalized Information Notice Corporation Taxes 2014-01, providing guidance regarding the sourcing of receipts from sales of services and intangibles for purposes of the net income and capital franchise tax apportionment factor. As addressed in our prior alert, pursuant to Pennsylvania Act 52 of 2013, Pennsylvania adopted market-based sourcing with respect to sales of services effective Jan. 1, 2014. Pennsylvania, however, did not extend this move to market-based sourcing to receipts from sales of intangibles, instead opting to continue to apply the state's income-producing activity test to these types of receipts. The notice provided the following guidance regarding the Department's interpretation of these rules:
Effective Jan. 1, 2014, Pennsylvania enacted market-based sourcing with respect to sales of services. In general, the statutory language created a three-part cascading test for sourcing sales of services:
- Rule one: Receipts from services are sourced to Pennsylvania if the service is delivered to a location within Pennsylvania. However, if the service is delivered both in and outside of Pennsylvania, the sale is sourced to Pennsylvania based upon the percentage of total value of the services delivered to a location within the state compared to services delivered elsewhere.
- Rule two: If the state(s) where the service is delivered cannot be determined under the first rule for a customer who is an individual that is not a sole proprietor, the service is deemed to be delivered at the customer's billing address.
- Rule three: In the case of customers who are not individuals or who are sole proprietors, if the state(s) of delivery cannot be determined for the customer, the service is deemed to be delivered at the location from which the service was ordered in the customer's regular course of operations. If the location from which the service was ordered in the customer's regular course of operations cannot be determined, the service is deemed to be delivered at the customer's billing address.
The notice provides guidance for interpreting "delivery" and "location" for purposes of applying the statutory sourcing rules. The Department advised that location means the location of the customer and that delivery to a location not representative of where the customer for the service is located does not represent completed delivery of the service. The Department did not expressly define delivery in the notice, but instead provided multiple examples covering common service business models. Specifically, the Department addressed:
- A service that is performed locally
- A service that is performed remotely on tangible personal property owned by the customer
- A service that is performed remotely and delivered in the form of incidental value tangible personal property
- A service that is performed remotely and delivered electronically
- A service that involves moving tangible personal property from one place to another
Based on the examples, if a service is physically performed at the customer's location, the service is deemed to be delivered there. However, if a service is performed remotely, the service is deemed to be delivered where the customer receives the service. For example, if a customer drops off his car at a garage and later returns to pick it up there, the location of delivery is the address of the garage. However, if a customer ships a damaged cell phone to a repair facility that then returns the cell phone to the customer, the location of delivery is the address of the customer. Therefore, the Department would appear to deem the location of delivery to be where the customer actually receives the benefit of the service.
The notice recognizes that a service may be delivered to a location in more than one state and expressly allows a multistate service to be sourced both to Pennsylvania and outside of Pennsylvania to the extent the service is used in the states. The Department permits taxpayers to use a reasonable and consistent method to apportion the services. Apportionment may be based on "expected usage," "actual usage," or "value of the usage." Please note that the taxpayer must be consistent from year-to-year and, therefore, must continue to use the selected method for those receipts in subsequent years.
The notice also provides guidance for more complex delivery situations, including, but not limited to, third-party delivery and electronic delivery. A third-party delivery scenario arises when an original service provider hires a third party to complete the ultimate delivery of the contracted services to the customer. The Department has determined that the delivery of the service from the customer's perspective occurs at the location where the customer actually receives it. In general, electronic delivery is sourced to the location of the purchaser where the service is consumed or used. Commonly, services are delivered to a customer in multiple locations. Therefore, the Department permits the apportionment of services delivered electronically to be accomplished by using IP address records or other network data if individual street addresses of customers are not available. However, the network data may only be used if it reasonably corresponds to locations where the data is delivered to actual customers.
Income from intangibles
Income from intangibles, including patents, copyrights, trademarks, trade names, money, equity, or debt securities, continues to be apportioned to Pennsylvania under the traditional income-producing activity method. In general, income from intangibles is apportioned to Pennsylvania if the income producing activity is performed entirely in the state, or, if the income producing activity is performed in more than one state, such income is apportioned to Pennsylvania if a greater proportion of the income-producing activity is performed in Pennsylvania than in any other state, based on costs of performance. The Department has advised that income-producing activity occurs when and where performance is accomplished or fulfilled. Further, the Department has advised that income-producing activity is determined at the transactional level rather than at the operational level and that only those activities a customer would separately pay for should be considered.
In applying this guidance to sales of intangibles, the Department provided a restaurant franchise example in which a Maryland-based restaurant chain grants franchises to individuals throughout Maryland and Pennsylvania. The franchisees pay the restaurant chain for the intangibles on an annual basis. The Department determined that in this situation, the income-producing activity is the franchisees' use of the intangibles and that, therefore, the receipts from intangibles licensed to Pennsylvania-based franchisees should be sourced to Pennsylvania because the franchisees' use of the intangibles occurred entirely within Pennsylvania.
Although the notice does not have the force of law or regulation, taxpayers should be aware that Pennsylvania courts have consistently given substantial deference to this type of guidance. Taxpayers should carefully consider the guidance provided and determine its impact on their sourcing positions. In particular, taxpayers should review the examples discussing when delivery will be deemed to occur within the state in relation to their specific facts and circumstances. Additionally, taxpayers should review their sourcing of income from intangibles, as the methodology described in the notice makes it possible that application of the income-producing activity method can mirror the result under market-based sourcing.