Market-Based Sales-Factor Sourcing
Market-based sourcing for corporate income tax and franchise tax has been the topic of proposed legislation for several years and it became a particularly hot topic after the phase-in of single sales factor apportionment was completed in 2018. Yet, North Carolina continued to source receipts from sales of services based on the location of the income-producing activity. With the enactment of S.B. 557 North Carolina has adopted market-based sourcing for all receipts for tax years beginning on and after January 1, 2020.
Under the new law, receipts will be sourced to North Carolina if the taxpayer’s “market” for the receipts is in the state. Similar to prior versions of proposed market-based sourcing legislation, S.B. 557 provides specific rules for determining the market for receipts from the following sources:
- Sales, rentals, leases, or licenses of real property;
- Rentals, lease, or license of tangible personal property;
- Sales of tangible personal property;
- Sales of services;
- Rentals, leases, or licenses of intangible property; and
- Sales of intangible property.
For example, under the rule for determining the “market” for receipts from sales of services, the market for a service is in North Carolina if the service is delivered to a location in North Carolina. Under the rule for determining the “market” for receipts from licenses of intangible property, the market is in North Carolina if and to the extent the intangible property is used in North Carolina.5 If the market for a particular receipt cannot be determined by application of one of the statutory rules, then S.B. 557 requires the use of a method of reasonable approximation. If reasonable approximation isn’t possible, then the receipts are excluded from the sales factor altogether.
S.B. 557 itself does not define what constitutes a method of “reasonable approximation,” nor does it define other key terms like “delivery”. However, S.B. 557 directs that the market-based sourcing rules adopted by the North Carolina Department of Revenue (the "Department”) and approved by the Rules Review Commission in early 2017 be entered into the Administrative Code and made applicable to tax years beginning on or after January 1, 2020. (The Department had been directed to modify these rules as necessary to comport with the enacted statutory language.) These administrative rules should help fill in some of the gaps in the legislation.
S.B. 557 also provides special rules for banks, wholesale content distributors, and electric power companies.6
- For banks, the rules for determining the market for receipts depends on the receipt type. S.B. 557 includes specific rules for determining the market for receipts such as interest, fees, and penalties from secured or unsecured loans; net gains from the sale of loans; ATM fees; and net gains from the sales of credit card receivables.
- For wholesale content distributors (broadcast television networks, cable program networks, or any television distribution companies affiliated with any such network), receipts from advertising, licensing, and distribution are sourced to North Carolina (1) if derived from a business customer whose commercial domicile is in the state, or (2) if derived from an individual customer whose billing address is the state. However, S.B. 557 also provides that a wholesale content distributor’s income apportioned to North Carolina using these “market” rules cannot be less than the total domestic gross receipts of the wholesale content distributor multiplied by 2%. This 2% minimum may result in a distorted apportionment for some wholesale content providers – especially those with total domestic gross receipts significantly in excess of income.
- Unlike other taxpayers, an electric power company must apportion its income using a single property factor, computed as a fraction with the average value of real and tangible personal property owned or rented in North Carolina in the numerator, and all real and tangible personal property owned or rented and used everywhere in the denominator.
Notably, S.B. 557 allows an election focused on utilization of North Carolina net losses generated by service-providers during years with “income-producing activity” sourcing. Under this election, a taxpayer can continue to source receipts from services using the income-producing activity test until its net losses from those years have been fully-utilized. This election must be made on the tax return for the 2020 tax year.