The letter ruling (201102989L) addresses the sourcing issue for a taxpayer that operates an internally-developed, Internet, social-networking website. The company has two principal streams of revenue: website access fees (generally paid by each user on a monthly basis) and online advertising revenue.
Internet users are able to access the company's website from any computer in the world. The Company's website is hosted on computer servers located in two different states. The servers in both states are simultaneously online, mirror each other and contain copies of the Company's website.
Users of the Company's website do not know which server facility they are connecting through when they access the website. The Company's servers dynamically balance the number of connections to each server facility so that at any given time fifty percent of users are connected to the servers in one state and fifty percent are connected to the servers in the other state. When the server facilities are both working at optimal levels. Each server facility is designed with redundancy in mind to take greater or lesser volume as necessary.
Upon connection to the Company's website, all users are directed to a registration page to register. Registered users can utilize the basic functionality of the Company's website for no charge (a free account).
The free account grants a user limited access to the website’s content. In order to gain additional access to the website, a registered user is required to establish a fee-based account. The fee-based account provides a user with full access to the website. Full access allows a user to (1) search the website’s database, (2) publish information, (3) communicate with other users, and (4) utilize and interact with the website’s programs. Fee-based users generally pay a flat fee on a monthly basis. This represents approximately ninety-five percent of the Company's annual revenue.
The Company also generates click-through revenue from third-party advertisers whose online advertisements are hosted on the computer servers located in both states.
In regards to the access fees, the ruling states that the membership fee is paid by the website users for access to the benefits the website provides. The gross receipts are based, not on usage of the website or solely being able to enter the website, but on access to specific benefits, much like any other membership.
Franchise tax rule 3.591(e)(17), Margin: Apportionment, states: “Membership or enrollment fees paid for access to benefits should be considered gross receipts from the sale of an intangible asset and are apportioned to the legal domicile of the payor.”
The gross receipts from the membership fees paid for website access to benefits are, therefore, sourced to the location of payor.
ONLINE CLICK-THROUGH ADVERTISING FEES
In regards to the advertising fees, the ruling states receipts from online click-through advertising are treated as commissions. Commissions are treated as revenue from the performance of a service.
Franchise tax rule 3.591(e)(26) provides that “Receipts from a service are apportioned to the location where the service is performed. If services are performed both inside and outside Texas, then such receipts are Texas receipts on the basis of the fair value of the services that are rendered in Texas.” Gross receipts from click-through advertising are apportioned to the location of service, which is the location of “the server that provides the link to the customer to purchase the item from the seller,” from STAR letter 200305904L.
Since the Company's servers are located in two states and the servers balance the number of connections between them, fifty percent of the click-through advertising revenue is apportioned to each state.
In this era where online commerce and social media websites are commonplace, companies need to know how to source revenue related to website access fees and ad revenue. For Texas purposes, a company needs to know the location of each payor and the location of its servers.
If you would like assistance in determining how to source your revenue in Texas or any other state, please contact me.