Both states and taxpayers have struggled with how to correctly source service receipts for apportionment purposes. The myriad of state sourcing provisions certainly do not add any clarity to the issue. Muddying the waters even further are those states that source services to the location of the income-producing activity based on costs of performance—yet the Departments of Revenue interpret those provisions to mean market-based sourcing.

A slew of recent cases, including Hegar v. Sirius XM Radio, Inc., No. 03-18-573-cv, (Tex. App. Nov. 10, 2022), have added some much-needed clarity to the issue. Included in the list of recent cases is the Florida Circuit Court decision in Target Enterprise, Inc. v. Fla. Dep’t of Revenue, Fla. Cir. Ct., No. 2021-CA-002158, (Nov. 28, 2022).

The Facts: The Target Enterprise case involved a subsidiary of Target Corporation. The subsidiary, Target Enterprise, Inc. (“TEI”), provided various services to Target and to third parties. TEI’s employees who performed those services were primarily located at TEI’s headquarters, in Minnesota.

For Florida corporate income tax purposes, TEI sourced its service receipts to the location of its employees. The Florida Department of Revenue (the “Department”) audited TEI and contended that TEI’s services should be sourced based on a percentage of Target Corporation’s retail square footage in Florida over Target Corporation’s total retail square footage in the United States. Notable, the Department’s method did not relate to any activity of TEI. The Department’s administrative rule sourced services to the location of the income-producing activity, which is determined based on the location of the costs to perform those services.

The Decision: The court in Target Enterprise held that this sourcing rule involves a two-step process. First, determine the taxpayer’s income producing activity. Second, balance the costs incurred to perform those services. In this case, the court held that “there can be no question that TEI’s ‘income producing activity’ was performing the services…[and those] services were performed by employees of TEI.”

Significantly, the court held that for services—as was at issue—the income-producing activity was the performance of that service, not some other incidental activity. This is an important victory for taxpayers that are battling Departments of Revenue that insist that the income-producing activity is something other than the performance of the service itself—for example, where the payment is made for the service or where the order for the service is placed.

In addition, the court held that the best evidence of TEI’s costs to perform the service was the payroll apportionment workpapers, which were provided to the Department during the audit. Thus, TEI had sufficiently substantiated its sourcing and the Department was without authority to adjust such sourcing.

In light of this recent taxpayer victory, companies should continue to evaluate where their receipts are sourced for those states that still source to the location of the income producing activity.

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