27th Annual Tuesday & Wednesday, January 23‐24, 2018 Hya� Regency Columbus, Columbus, Ohio Workshop I Ohio Tax Service Industries Case Study: The New Majority: Shift from Cost of Performance to Market-Based Sourcing Tuesday, January 23, 2018 1:45 p.m. to 2:45 p.m.
Biographical Information Michael A. Grim, JD, Tax Principal, MCM LLP 2600 Meidinger Tower, 462 S. 4th St., Louisville, KY 40202 502-882-4510 Fax: 502-749-1930 mike.grim@mcmcpa.com Michael A. Grim, JD, MBA is a tax partner resident in the Louisville office of Mountjoy Chilton Medley LLP, where he practices in the Tax Group. His practice focuses on controversy, audit, and planning related to federal, state and local tax matters. Michael is a frequent speaker and author on various tax topics. His areas of practice concentration are federal, state and local taxation, tax controversy, and tax planning. He has previously litigated matters before various state and local tax boards, state and federal courts, as well as U.S. Tax Court. He has counseled clients on various issues involving federal, state, and local income taxes, employment taxes, gross receipts taxes, sales/use taxes, real and tangible property taxes, local license/business taxes, and various excise taxes (e.g., fuel and transportation excise tax). Prior to joining MCM, Michael was with the law firm of Bingham Greenebaum Doll LLP for 10 years, were he was a partner in the Tax & Finance Practice Group, and the chair of the firm’s State & Local Tax practice. Prior to joining BGD, Mike worked for United Parcel Service for nearly 19 years. His last two assignments, which were concurrent, were as the UPS Airline Tax Director and UPS Airline Contracts Manager. As the Airline Tax Department Manager, Mike had worldwide responsibility for all tax matters related to UPS’s airline operations, including international, federal, state and local tax issues. Erica L. Horn, Associate Director of Tax Services, Dean Dorton 106 W. Vine Street, Suite 600, Lexington, KY 40507 859-425-7674 Fax: 859-425-3674 ehorn@deandorton.com Erica started her professional career with KPMG in 1983. In 1987, Erica left public accounting for law school. Upon graduation, she practiced law for approximately 27 years with over half of those years spent doing state and local tax controversy work. Erica return to public accounting in October 2017 but her focus remains on all things state and local tax. Erica is passionate about making sure businesses do not pay a penny more in tax than is required by law. Erica has experience in a wide-range of industries including manufacturing, construction, equine, warehousing and distribution. She has represented multistate and international companies in tax controversies before the Kentucky Department of Revenue, Kentucky Claims Commission (formerly Kentucky Board of Tax Appeals) and the state and federal courts of the Commonwealth. She is a prolific speaker and author on multistate tax topics. Through her advice and advocacy, Erica has saved her clients millions of dollars in Kentucky taxes. Erica is a graduate of Transylvania University with a B.A. in Business Administration, and earned her J.D. at the University of Kentucky College of Law in Lexington, KY.
27 th Annual Ohio Tax Conference The New Majority: Shift from Cost of Performance to Market‐Based Sourcing January 23, 2018 Michael A. Grim, Tax Partner Erica L. Horn, Associate Director of Tax Services
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Q & A • I came to this session because: A. I’m passionate about sourcing. B. The other topics didn’t interest me. C. I’m trying to get a head start on my CPE. D. I wanted to see if people from KY wore shoes. 3
Background • Uniform Division of Income for Tax Purposes Act (“UDITPA”) was promulgated by the Uniform Law Commission (“ULC”) in 1957. • In August 1967, the Multistate Tax Commission (“MTC”) was created by the Multistate Tax Compact (“Compact”) in an attempt to promote uniformity in state laws. UDITPA is Article IV of the Compact. 4
Q&A • I think the idea of “uniformity among the states” … A. Is great. B. Would make my job boring. C. Is just silly. 5
Background • Article IV of the Compact originally used an equally weighted three‐factor formula to apportion income of a business in a state. • The three factors were a company’s property, payroll, and sales. 6
Background • Each factor used a fraction, the numerator of which consisted of the factor’s in‐state amount (e.g., payroll, property, or sales) and the denominator of which consisted of the factor’s total amount everywhere. 7
Background • One of the questions that arose regarding the sales factor was how to decide the amount of sales attributable to each state. • In other words, to what state would the sales be “sourced”. 8
Background • At the time, most businesses generated sales from selling tangible personal property to customers located in reasonable proximity. – Sales were to be sourced based on the destination of the sale; i.e., sales were sourced to the state in which the product was delivered or shipped. • Sales of services were generally professional services such as accountants, lawyers, doctors, etc. – Sales of services were to be sourced based on location of the income‐producing activity. 9
Original Sourcing of Services Article IV provided under the original Compact that: • Sales, other than sales of tangible personal property, are in this State if: – a) the income‐producing activity is performed in the State; or – b) the income‐producing activity is performed both in and outside this State and a greater proportion of the income‐producing activity is performed in this State than in any other State, based on costs of performance. 10
Economic Changes • The economy has transitioned from being primarily manufacturing to service‐based. Fewer people and less property are needed to generate revenue. • During this transition, states have started moving toward the use of a single‐sales factor apportionment formula for all industries, not just service industries. 11
Changes and Amendments • Accompanying the shift to single‐sales factor apportionment, states have moved away from cost‐of‐performance and to market‐based sourcing. • In July 2015, Article IV (UDITPA) of the Compact was amended such that, “receipts, other than [for tangible personal property], are in this State if the taxpayer’s market for the sales is in this state.” 12
Current Sourcing of Services • Now, there are roughly 3 separate approaches to sourcing of services, depending on the state: – Preponderance‐cost‐of‐performance (all‐or‐ nothing) – Pro rata cost‐of‐performance – Market‐based (“in this State if the taxpayer’s market for the sales is in this state”) 13
Q&A • How do you determine “if the taxpayer’s market for the sales is in this state”? A. Select the state that provides the most advantageous result to the company. B. Throw a dart at a map of the United States that shows the states in which the company does business. C. I thought that’s what you were going to tell me. 14
Market in this State? CA • To the extent the purchaser receives the benefit of the service in this state. • Where is the benefit of the service? – Location set forth in contract – Based on a “reasonable approximation” – Billing address of purchaser » CA Rev. & Tax. Code, Section 25136. 15
Market in this State? MA • The location where the service is received. • Where is this “location”? It depends on whether … – The service is delivered in‐person; – The service is a “professional service”; or – A transportation or delivery service. » 830 CMR 63.38.1 • Same approach followed by MTC, TN, RI. 16
Case Study: Sourcing • ABC arranges seminars in different states. • ABC has two revenue streams, one from registration fees (for attendees) and another from sponsorships (exhibitors). 17
Case Study: Sourcing • All of ABC’s payroll and property are located in Louisville, Kentucky. • “Sales” are generated via internet, direct mail, telephone, and e‐mail from ABC’s sole office in Louisville, Kentucky. 18
Case Study: Sourcing • In 2017, ABC decides to put on a “self‐help” seminar in Los Angeles, California. • 500 attendees pay $1,000 each to attend, which generates $500,000 in “attendee revenue” • 30 exhibitors pay $5,000 each, which generates $150,000 in “sponsorship revenue” 19
Case Study: Sourcing • The only work performed in California is on the date of the seminar where ABC assists attendees with registration and helps exhibitors set up. • Otherwise, all the work related to the seminar is done in Kentucky. 20
Case Study: Sourcing • Kentucky is a “cost of performance” state (receipts sourced to predominant location of income‐producing activity) • California is a “market‐based” sourcing state (receipts sourced to where the purchaser received the benefit) • Receipts are $650,000 – $500,000 in attendee fees – $150,000 in sponsorship revenue 21
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