In a letter of findings, the Indiana Department of Revenue applied a market-based sourcing method and required an out-of-state taxpayer to include receipts from audience profile information that it sold to Indiana customers in its sales factor.1 The Department determined that the taxpayer earned its money from compiling and analyzing data from public opinion surveys that it conducted in other states. According to the Department, the "income-producing activity" took place in Indiana, the state where the services were provided to Indiana customers and the taxpayer derived its income. The Department used a market-based method to source the taxpayer's income to Indiana, even though Indiana is a cost of performance state and the taxpayer did not perform any services within the state.
Background
The taxpayer, an out-of-state media and marketing services business, conducted public opinion surveys to measure the number and characteristics of audience members listening to television and radio programs. After conducting the surveys outside Indiana, the taxpayer compiled the survey results and sold this information to its customers in Indiana. For purposes of its sales factor used to apportion income to Indiana, the taxpayer did not include money received from selling audience and polling information to Indiana customers. The Department audited the taxpayer and included in the sales factor money received from selling this information to customers in Indiana. The taxpayer argued that the additional assessment was incorrect and that the money received from the Indiana customers should not be included in the sales factor. In response, the Department conducted an administrative hearing and issued a letter of findings.
Apportionment of Income
For the tax years at issue, Indiana used a three-factor apportionment formula comprised of property, payroll and sales factors.2 Under Indiana law, the sales factor is a fraction, the numerator of which is the taxpayer's total sales in Indiana during the taxable year, and the denominator of which is the taxpayer's total sales everywhere during the taxable year.3 Sales other than sales of tangible personal property are in Indiana if: (i) the incomeproducing activity is performed in the state; or (ii) the income-producing activity is performed within and without Indiana and a greater proportion of the income-producing activity is performed in Indiana than in any other state, based on costs of performance.4 A regulation defines "income producing activity" as "the act or acts directly engaged in by the taxpayer for the ultimate purpose of obtaining gains or profit."5
Income-Producing Activity Occurred in Indiana
The Department determined that the taxpayer's receipts from selling the audience profile information should be sourced to Indiana because the taxpayer provided the services and derived the income in the state. In rejecting the taxpayer's argument that the money was earned by conducting surveys at out-of-state locations, the Department explained that the money was received from compiling and analyzing the data received from the surveys and selling the compilations of data to Indiana customers.
The taxpayer argued that its core business was conducting public opinion surveys outside Indiana and that the receipts should not be sourced in Indiana. In support of its argument, the taxpayer cited a regulation that provides receipts from the performance of personal services are attributable to Indiana to the extent the services are performed in the state.6 The taxpayer specifically asked the Department to consider an example in the regulation that concerned a public opinion survey corporation.7 In the example, the corporation's employees conducted a poll in Indiana and another state for a fee. Using a "time spent" methodology, because one-third of the time to obtain the data and prepare the report was spent in Indiana, one-third of the fees was sourced to Indiana. As the taxpayer spent no time in Indiana, the taxpayer contended that no receipts should be sourced to Indiana under the time spent approach.
The Department determined that the taxpayer's reliance on this example was unfounded. As explained by the Department, the example involved income-producing activities that were performed in Indiana and another state. In contrast to the example, the out-of-state surveys that the taxpayer conducted did not produce income because the taxpayer was not paid money to conduct the surveys. The Department concluded that the taxpayer actually was paid for selling compilations of data based on the surveys to Indiana customers. As a result, the Department held that since Indiana was the place where services were provided to Indiana customers, the income-producing activity with respect to those sales took place in Indiana.
Commentary
Indiana is a cost of performance state, but the Department applied a market-based sourcing methodology in this instance.8 There is a state trend toward market-based sourcing and some states have adopted this methodology by enacting legislation, while a few other states have considered using this methodology pursuant to regulation or audit policy, even though statutes in these states clearly endorse the use of a cost of performance approach. For this reason, it is questionable as to whether the Department's attempt to use a new sourcing methodology could survive a legal challenge.
The Department's dismissal of an example in the regulation that closely aligns to the taxpayer's facts is somewhat troubling. But even if the Department's characterization of the taxpayer's business as selling compilations of data rather than conducting surveys is taken at face value, that characterization should not change the overall conception of the taxpayer's activity as a personal service requested by its customers.9 The rules applicable to personal services arguably would still require looking at where the taxpayer spent time in earning the receipts, which was outside the state.
The Department's strained attempt to effectively achieve market-based sourcing results in uncertainty for taxpayers that historically thought that Indiana's cost of performance statute and regulation precluded the use of market-based sourcing. At the same time, apportionment rulings often act as a double-edged sword. For example, taxpayers currently adversely impacted by a cost of performance methodology (like corporations with significant in-state payroll costs that sell to a worldwide market base) may stand to gain from the Department's approach taken in the letter of findings.
Footnotes
1 Letter of Findings No. 02-20120316, Indiana Department of Revenue, Nov. 28, 2012.
2 IND. CODE § 6-3-2-2(b). Indiana historically used a three-factor apportionment formula with a double-weighted sales factor. For tax years beginning after December 31, 2006, Indiana began phasing to a single sales factor. Indiana has completely phased to a single sales factor for tax years beginning after December 31, 2010.
3 IND. CODE § 6-3-2-2(e).
4 IND. CODE § 6-3-2-2(f).
5 IND. ADMIN. CODE tit. 45, r. 3.1-1-55.
6 IND. ADMIN. CODE tit. 45, r. 3.1-1-55(d).
7 IND. ADMIN. CODE tit. 45, r. 3.1-1-55(d), example 2. This example is adapted from the Multistate Tax Commission's regulation addressing personal services. See MTC Reg. IV.17(3), (4)(B)(c)(example (ii)).
8 Note that courts in other states have reached similar results in cases where the taxpayer received advertising revenue from telephone directories. Tennessee is a cost of performance state, but in Bellsouth Advertising & Publishing Corp. v. Chumley, 308 S.W.3d 350 (Tenn. Ct. App. 2009), the Department of Revenue was allowed to issue a variance from the standard apportionment formula for a taxpayer that derived revenue from advertising in telephone directories distributed in Tennessee. The advertising revenue was apportioned to Tennessee even though the costs of performance occurred outside the state. In Ameritech Publishing, Inc. v. Department of Revenue, Wisconsin Court of Appeals, No. 2009AP445, June 24, 2010 (unpublished), Wisconsin used the cost of performance method for the disputed tax years. The Court determined that the taxpayer's income-producing activity was "the furnishing of access to a Wisconsin audience via advertisements placed in its local telephone directories."
9 It is surprising that the Department did not take this opportunity to define the term "personal services" in the letter of findings, in its attempt to distinguish the taxpayer's activities from the conducting of surveys explained in the personal services regulation.
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