Sales Factor Sourcing of Services & Intangibles

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We still are waiting for the Pennsylvania Department of Revenue (the “Department”) to publish official guidance on the apportionment changes made by Act 52 of 2013.  Effective for tax years beginning after December 31, 2013, the Act provides new rules for the sourcing of receipts from services in the corporate net income tax and franchise tax sales factors.  A draft information notice dated June 16, 2014, was circulated confidentially to organizations representing business and industry, the bar and CPAs.  Extensive comments were submitted at the end of July.  Presumably, the Department is rewriting the draft notice, taking those comments into account.

For years prior to 2014, receipts from sales of services and intangibles were subject to the UDITPA-based “income-producing activity” and “costs of performance” analysis.  If the income-producing activity was performed in one or more states, in addition to Pennsylvania, the receipts from those activities were sourced to PA if the greater proportion of the income-producing activities, as measured by costs of performance, occurred in PA.  While the Department never published a regulation addressing this analysis, and while audits sometimes took inconsistent positions, the Department did publish two letter rulings applying these rules. 

 

The letter rulings focused on all of the activities performed by the taxpayer in producing the sales in question.  Generally, the letter rulings indicated that receipts from intangibles, such as license fees, would be sourced to the commercial domicile on the basis that the state of commercial domicile is “where a taxpayer generally manages and maintains intellectual property.”  Ruling No. CRP-06-004, 10/10/2006.  While we do not think it appropriate to discuss the particulars of the Department’s confidential draft information notice, we note that it did address income from intangibles as well as the new rules for services, and did not follow the prior letter rulings.  At this point, it is impossible to know what the Department will do when it publishes official guidance.

 

Under Act 52, receipts from sales of services are now attributed to Pennsylvania if “delivered to a location” in PA.  72 P.S. §7401(3)2.(a)(16.1)(C)(I). If delivered to other states as well as PA, the receipts are to be allocated “based upon the percentage of total value of the service delivered to a location in [PA].”  Id. at (16.1)(C)(II).

 

Where the point of delivery cannot be determined, the following defaults apply:

  • If the customer is an individual who is not a sole proprietor, delivery is deemed to be at the customer’s billing address.  Id. at (16.1)(C)(II).
  • If #1 does not apply, the service first would be deemed to be delivered “at the location from which the services were ordered in the customer’s regular course of operations.”  Id. at (16.1)(C)(III).
  • If the answer under #2 cannot be determined, the service is deemed to be delivered at the customer’s billing address.  Id.

Unfortunately, Act 52 does not define “delivered.”  However, inasmuch as receipts from sales of tangible personal property have long been sourced to the point of delivery, one would think that some analogies could be drawn. 

 

For example, the point of delivery of tangible personal property is not necessarily the location where the customer ultimately puts the property to use.  Therefore, one would assume that the Legislature did not intend for the location where a service is “delivered” to necessarily correspond to the point of ultimate use.  This is consistent with the provision specifically providing for receipts from rental or lease of tangible personal property which is subsequently taken out of state to be sourced (at the taxpayer’s election) based on “a reasonably determined estimate of usage in [PA].”  Id. at (16.1)(B)(II).  If the Legislature intended a similar “usage” rule for services, the Legislature presumably would have said so.

 

But what if a service is performed primarily in a state other than Pennsylvania, the service would provide a general benefit to the customer company, the work product from the performance of the service (e.g., a marketing study) is delivered to an address in another state outside of Pennsylvania, but in the course of performing the service the service-provider was in touch with company personnel both inside and outside of Pennsylvania? Is this a case where the point of delivery really cannot be determined and the default sourcing rules should come into play?  Or would the PA Department of Revenue take the position that the point of delivery could be determined on these facts?

 

The attribution of service receipts to the location where the service is “delivered” is a relatively new concept.  Guidance is required from the Department of Revenue so that a company may prepare its Pennsylvania tax report with some degree of certainty that it is not unexpectedly opening itself to a dispute with the Department of Revenue.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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