United States: Colorado Finds Cost Of Performance Sales Factor Sourcing Best Fit For Receivables Company

The Colorado Department of Revenue has issued guidance to a receivables company in the form of a private letter ruling regarding how to apply sales factor apportionment rules.1 Specifically, the Department determined that the company was a service provider and should source its gross receipts based on where the cost to perform the service was incurred.


The Colorado-based taxpayer was primarily engaged in the acquisition, management, and collection of charged-off consumer and commercial accounts receivable. The taxpayer's primary source of gross receipts was from collection of these receivables. Upon purchasing these assets at a discount, the taxpayer placed the accounts for collection with one of its branch offices,2 which were located across the country and had agreed to work exclusively for the taxpayer.3 The taxpayer paid its branch offices a variable fee generally based upon performance against standard return assumptions.

Historically, the taxpayer apportioned 100 percent of its operating revenue to Colorado. The taxpayer had concluded that its receipts, which did not clearly fall within any of the enumerated statutory classes for which apportionment treatment is specified, most closely mirrored gains or sales of intangible property or interest income. Accordingly, the taxpayer had apportioned its sales based solely on its commercial domicile. In doing so, the taxpayer accumulated significant Colorado net operating losses.

Upon reviewing its apportionment methodology, the taxpayer concluded that its revenue did not constitute interest income or gains from the sale of intangible property. Instead, the taxpayer asserted that the most logical approach to determine its Colorado sales factor was to utilize the special apportionment regulation applicable to financial institutions. The taxpayer requested a private letter ruling from the Department to determine how to apportion its income when it "does not squarely fit into existing apportionment methodologies."4

Private Letter Ruling

Allocation and apportionment of income is required to determine Colorado taxable income for entities with sources of income both inside and outside Colorado. Colorado generally employs a single sales factor to apportion business income.5 Sales factor sourcing rules are provided for specific types of income, as well as for certain industries such as financial institutions.6

Addressing the taxpayer's contention that it should utilize the apportionment rules applied to financial institutions, the Department found that the taxpayer was not a financial institution.7 Specifically, the taxpayer did not meet this definition because it did not handle financial transactions and did not provide financial services to customers. Accordingly, the taxpayer was not able to allocate and apportion its income based upon the financial institution sourcing rules.

In lieu of a specific sourcing rule that might be applicable to the taxpayer's revenue stream, the Department then focused on three general sourcing rules to determine the most reasonable method to source the taxpayer's receipts. These rules specify how to source income from: (i) gain or loss from the sale of intangibles; (ii) interest income; and (iii) revenue from services performed in Colorado.8 First, the Department agreed that the taxpayer should not source its income as a gain or loss from the sale of intangible assets as such income generally arises when an asset is sold to a third party. Although the taxpayer purchased accounts receivable (an intangible asset), no income was generated from the sale of this asset. Next, the Department found that the income received by the taxpayer was not interest as it was not earned for the time value of money, but was instead a repayment of principal debt. Finally, the Department considered whether the taxpayer could be considered a service provider. Based on the fact that the taxpayer used its Colorado staff and the staff from its branch offices located elsewhere to generate income from delinquent debt, the Department found that the taxpayer engaged in a service. In reaching this conclusion, the Department acknowledged that characterization of the taxpayer as a service provider was unusual because a service provider typically generates income by selling its services to a third party. In this case, the taxpayer consumed its own services to generate income.

As a result of its characterization as a service provider, the taxpayer was required to use the statutory method provided to source its income from services. Specifically, receipts from services performed within and outside Colorado are sourced based upon where the direct costs are incurred in the performance of that service.9 The Department also provided that, for purposes of determining the cost of performance of the rendered service, if the taxpayer did not have cost records for previous tax years to substantiate where its cost of performance took place, it could use its current cost of performance results to determine the proportionate Colorado net operating losses. In order to extrapolate this data, the taxpayer also needed to verify that the operating facts of the taxpayer's business have not substantially changed from the periods during which the net operating losses were earned.


While other states have increasingly adopted market-based sourcing rules either through legislation or on an individual taxpayer basis through the audit process or administrative rulings, Colorado appears to be content with its cost-of-performance rules for sourcing services for the time being. This private letter ruling provides valuable guidance for any other taxpayers engaged in lines of business not directly addressed in the current Colorado apportionment statutes. Although the private letter ruling cannot be relied upon by other taxpayers, it is certainly indicative of the Department's thought process regarding sales factor sourcing. The analysis contained in the ruling also might be worthwhile to consider in developing sales factor sourcing positions in other states where a revenue stream is not clearly covered by existing statutes or regulations.

Interestingly, in the footnotes included in the ruling, the Department notes that it intends to propose a modification to the service provider rule to clarify that the sourcing rule can include entities whose services generate income or create a special regulation for the debt collection industry. The Department noted that when this new rule is adopted, the taxpayer must prospectively follow the new rule. Inclusion of this language seemingly makes apparent a Department view that this issue affects a significant subset of taxpayers, and perhaps other similarly situated taxpayers have not sourced this type of revenue stream in a consistent manner. It remains to be seen whether the new rule will provide for the same sourcing methodology relied upon by the Department in this ruling, or whether a market-centric approach will be taken.


1 PLR-15-006, Colorado Department of Revenue, June 8, 2015.

2 The branch offices were affiliated but independently-owned third-party law firms.

3 Accounts were allocated to the branch offices based on their capacity, geographic coverage, performance, and adherence to operational requirements

4 Pursuant to 1 COLO. CODE REGS. 201-1, § 24-35-103.5, taxpayers may request private letter rulings. Note that such rulings are premised on the assumption that the requesting taxpayer has completely and accurately disclosed all material facts. The ruling cannot be relied upon by any taxpayer other than the taxpayer to whom the ruling is made.

5 COLO. REV. STAT. § 39-22-303.5.

6 Id.; 1 COLO. CODE REGS. 201-2, § 39-22-303.5.4(C); 201-3, SPECIAL REGULATION 1A—8A.

7 1 COLO. CODE REGS. 201-3, SPECIAL REGULATION 7A(1)(b)(vi). Other factors included in the definition of "financial institution" and considered in this determination were that the taxpayer: (i) was not registered under state or federal law as a bank, saving association or thrift institution; (ii) was not organized for the purpose of engaging in international or foreign banking or other international or foreign financial operations nor an agency or branch of a foreign depository; (iii) was not a production credit association; and (iv) did not derive more than 50 percent of its total gross income from finance leases.

8 COLO. REV. STAT. § 39-22-303.5(4).

9 COLO. REV. STAT. § 39-22-303.5(4)(c).

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