With all the hoopla about the Massachusetts Tech Tax, we almost forgot about its sister act. We were reminded when on Monday of this week the Massachusetts DOR issued a working draft of TIR 13-15 which deals in part with a revised method for apportioning sales other than tangible property.
As the Massachusetts “Tech Tax” dies a slow but timely death, its ugly step-sister, “Market-based Sourcing” of sales enacted as part of the same Transportation Act, is alive and well.
This change will affect the sales portion of the three-factor formula (sales, property, and payroll) that business use to apportion their profits across the states in which it does business (“Nexus”). The theory is, a given set of apportionment criteria consistent across all states will result in a company paying total state tax in the aggregate on not more than 100% of its total taxable income.
However, many states have developed their own unique formula by tweaking one or more of those three factors. Some double count the sales factor, others may even ignore one of the three factors. When dealing with the sales factor, states are not consistent in how a particular sale gets assigned to their particular state. This is further complicated when dealing with a group of commonly controlled (e.g. “Unitary group”) companies and determining which sales are included in each separate company for a given state. The two methods of sales apportionment for a unitary group are known as the “Finnegan” or “Joyce” methods, named for California tax cases that determined the two approaches. Anyway, we won’t go into that quagmire.
The most common issue dealing with the sales factor is in which state the actual sale would be sourced. That is, would the sale be assigned to the state where the vendor or service provider actually performed the work or to the state in which the customer resides? With the exception of Government contracts, most states assign the sale to the state in which the services are performed. When the services are performed in multiple states, a long-standing “cost of performance” principle is usually applied.
In this new Massachusetts “Market-based Sourcing” of sales, the location of the customer will dictate where that sale gets assigned. Proponents argue that this simplifies the process by removing the “cost of performance” debate. I think it will merely shift more income to Massachusetts and also add a further complication when the use of those services are not limited to one location…(remember sister “tech tax” Multiple Points of Use?). More importantly, whenever there is inconsistency in how each factor is calculated, it is very likely a business will end up apportioning more than 100 percent of its income to the various states in which it does business.
A simple example of this issue would be a New Hampshire service company with a total of $300 of sales including $100 to a customer in Massachusetts, all of which is performed at its New Hampshire location. Under current law, $300 of sales (100%) would be apportioned to the New Hampshire company because that is where the work was performed and none would be assigned to Massachusetts since no work was performed there. Under the new rules, New Hampshire would not change so all of its $300 sales would still be sourced to New Hampshire. However, Massachusetts would now pick up $100 of sales in its apportionment so 33% would be apportioned to Massachusetts. So now our New Hampshire company is apportioning a total of $400 in its sales factor when it only had $300 of actual sales. This would result in the New Hampshire company paying state income taxes on more than 100% of its total taxable income thereby increasing its overall state tax burden.
We are not picking on Massachusetts because many states are “dialing for dollars” and there are inconsistencies in the apportionment criteria with other states as well. We only make note of this one because it will affect our regional businesses (including our firm) and it continues to highlight the need for more uniform application of apportionment rules across state lines.