Indiana only cares about where the sale of a service is ‘rendered.’
Costs-of-performance does not matter.
A recent Letter of Finding held that an out-of-state company’s
income from providing online educational services earned from Indiana students
should be sourced to Indiana because the sourcing is based on where the sale is
'rendered,' not based on the costs-of-performance that the taxpayer incurred
outside Indiana.
INCOME-PRODUCING ACTIVITY
Indiana law defines “income producing activity” as the act
or acts directly engaged in by the taxpayer for the ultimate purpose of
obtaining gains or profit. In the Letter of Finding, the state held that the
'sales to Indiana customers' were the acts directly engaged in by the taxpayer
for the purpose of obtaining gains or profit, not the product development and
information technology costs the taxpayer incurred outside Indiana.
According to Indiana, the taxpayer does not earn money from
hiring or training its faculty members, from developing online courses or
course materials, or from incurring local overhead expenses. The taxpayer does
not earn money because its Indiana online students pay the taxpayer to incur
out-of-state expenses or conduct out-of-state research or development
activities on those students' behalf. The taxpayer earns money because it
prepares online educational services and then sells those services to Indiana
customers within their home state.
SOURCING
According to Indiana, the issue is not the cost of the
development of the educational services; rather the question is the destination
of sales through provision of services.
According to Indiana law, the income producing activity is
deemed performed at the situs of real, tangible and intangible personal
property or the place where personal services are rendered. The word “rendered”
means to transmit or deliver. Consequently, Indiana believes sales are obtained
because services are ‘rendered,' and services are rendered where the customer
is located.
INTERESTING STATEMENT
According to the Letter of Finding, “formulary apportionment
is designed to align the income tax multistate taxpayers report to the states
in which they conduct business with that taxpayer's business activity conducted
in those states. Formulary apportionment is not designed to create income
untaxed by any state or to exclude money earned from Indiana business activity
from the Indiana sales numerator.”
PROBLEMS WITH INDIANA'S TREATMENT
If we accept Indiana's conclusion that the taxpayer earns money because it prepares online educational services and then sells those services to Indiana customers within their home state, then it seems that the activity of "preparing" and the activity of "selling" are one income-producing activity. The taxpayer can't have revenue in Indiana without the preparing or the selling. As a result, the income producing activity related to the Indiana sale occurred partly within Indiana and partly without Indiana. Based on Indiana statutes and regulations, this requires the taxpayer and Indiana to use the costs of performance method.
Is the actual 'rendering' of the service in Indiana? Indiana regulations and statutes provide that gross receipts for the performance of personal services are attributable to this state to the extent such services are performed in this state." The statute or regulation does not define "rendered' as "transmit or deliver" as mentioned in the Letter of Finding. Consequently, Indiana may be the 'receipt' of the service, but the actual rendering, delivering or performance may occur outside Indiana, in this case by a professor. Or if we want to say the service was transmitted via a server, where the server is located. Saying a service is 'rendered' where the customer is located is not accurate. That is why states have gone to a 'market-based' sourcing method versus income-producing activity and costs-of-performance method. Meaning, a 'market-based' sourcing method would allow Indiana to source sales of services based on where the customer is located. However, this is not Indiana law.
ACTION STEP
Companies who provide services or sell online services to customers in Indiana should re-examine the apportionment and sourcing methodology they utilize to file their Indiana income tax return.
FINAL COMMENT
Indiana has had several Letter of Findings that have ruled in similar fashion, supporting Indiana's point of view. I disagree with Indiana's view point; however, taxpayers should be cautious in taking an opposing position without considering the potential result.
FINAL COMMENT
Indiana has had several Letter of Findings that have ruled in similar fashion, supporting Indiana's point of view. I disagree with Indiana's view point; however, taxpayers should be cautious in taking an opposing position without considering the potential result.