Tax Implications of the Final Massachusetts Market-Based Sourcing RegulationsJanuary 26, 2015
Christopher C. Della Valle, CPA, MST
The Massachusetts Department of Revenue (“DOR”) recently released a final regulation 830 CMR 63.38.1 addressing the 2013 statutory change to its sourcing rules for the sale of services and transactions involving intangible property in Massachusetts. Under the new statute, all entity taxpayers (including C corporations, S corporations and partnerships) are required to use market-based sourcing rather than cost of performance for the assignment of these gross receipts in the income apportionment calculation. The final regulations are effective for taxable years beginning on or after January 1, 2014 and are extremely important for companies and practitioners to review based on the level of complexity and wide range of taxpayers who will be impacted by the change.
Under the new regulations, Massachusetts establishes guidelines of what is considered a taxpayer’s market for sales other than sales of tangible personal property and to what extent a sale is considered to be in the state. In general, a taxpayer’s market for sales other than sales of tangible personal property in Massachusetts is as follows:
- In the case of a sale, rental, lease or license of real property, the sale is in Massachusetts to the extent the property is located in Massachusetts.
- For sales of services, the taxpayer’s market is determined based on the place of delivery in Massachusetts. In-person services (services physically provided in person by the taxpayer or third-party contractor where the customer is located) establish the taxpayer’s market for apportionment purposes as the customer location where the service is delivered and received. Examples of in-person services include warranty and repair services, cleaning services, plumbing or carpentry services, landscape services, medical and dental services and in-person training or lessons. For professional services that require specialized knowledge or certification and a higher level of approximation (legal, accounting, consulting, etc.), sourcing generally depends on whether the customer is an individual or a business customer and how much information is available related to the customer’s primary residence or location where the contract is managed.
In cases in which the service is neither an in-person service nor a professional service, the service falls into the “other services” category. For these other services, the final regulation distinguishes between services that are delivered to a customer and services that are delivered on behalf of a customer to a third party, and by the type of methodology – either through physical or electronic means. Depending on type of delivery and methodology, the sourcing of the other sales could be based on the state of delivery, on reasonable approximation or on the customer’s address.
For the license and lease of intangible property, the receipts are in Massachusetts if and to the extent the intangible is used in Massachusetts with “use” being defined as the location of the taxpayer’s market rather than the location of the taxpayer’s property or payroll. In addition, the determination of the “location” is predicated on the classification of the intangible being licensed in the transaction as either a marketing intangible, which includes the license of a trademark or trade name (receipts sourced to the location of customers purchasing goods or services), or a production intangible, which includes the license of a patent, copyright or trade secret to be used in a manufacturing process (receipts sourced to location of use of the intangible). If the taxpayer is not taxable in the state to which the license of the intangible is assigned, or the license is structured as a sale of goodwill or other similar intangibles, the license receipts are excluded from both the numerator and denominator for apportionment purposes.
For the sale of intangible property, the receipts from the sale or exchange of intangible property previously assigned to the state of the taxpayer’s commercial domicile would default to be excluded from both the numerator and denominator exclusive of a few specific situations based on the nature of the intangible property being transferred, or if the sale is of a partnership interest.
In situations in which the market cannot be determined, the regulations also establish a methodology to “reasonably approximate” which state or states should include the sale and exclude from the sales factor calculation any sales that cannot be assigned to a state through reasonable approximation. The methodology requires a level of judgment by the taxpayer applied “in good faith, on a consistent basis from year to year, and based on all sources of information available to the taxpayer”. The taxpayer is also required to maintain contemporaneous records to substantiate the reasonable approximation methodology and the assumptions for assignment of its sales and have them available for the Massachusetts DOR upon request.
Once a taxpayer establishes a methodology of reasonable approximation for assignment of sales in an originally filed return, the methodology is assumed to be correct, and neither the taxpayer nor the Commissioner may modify the methodology applied (through either an amended return or state audit adjustments). However, a change of methodology can be requested by the taxpayer in subsequent years, through the proper disclosures, which may or may not be approved by the Commissioner.
The final regulations for market-based sourcing are effective for taxable years beginning on or after January 1, 2014 and will have widespread implications for a number of taxpayers. The final regulations should serve as an outline for taxpayers to the new statutes, but will require more clarity and real life application before its full impact can be realized. Taxpayers with sales of services and transactions involving intangible property should consult with their tax advisers about developing an overall multistate approach to the new regulations and the decisions required in determining the proper sourcing approaches.
830 CMR 184.108.40.206(d)(2).
830 CMR 220.127.116.11(d)(4)(a).
830 CMR 18.104.22.168(d)(5).
830 CMR 22.214.171.124(d)(1)(d)(i).
830 CMR 126.96.36.199(d)(1)(d)(i).
830 CMR 188.8.131.52(g)(i)-(iv).
Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statues, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.