United States: North Carolina Mandates Informational Reporting Of Market-Based Sourcing Apportionment Calculation

On September 18, 2015, North Carolina Governor Pat McCrory approved legislation enacting significant changes to the taxation of corporations.1 One such change is a requirement that certain corporate taxpayers file an additional informational report to provide the state with information to study the impact that market-based sourcing of sales of items other than tangible personal property might have on corporate income tax collections.2 On October 1, 2015, North Carolina amended the original legislation, in part to provide clarifying guidance on market-based sourcing informational reporting.3

Market-Based Sourcing Informational Report

As part of the enacted legislation, North Carolina is phasing in a single sales factor apportionment formula over the next several years.4 Concurrently, the Department of Revenue is studying the potential impact of a change from the current cost of performance sourcing methodology to market-based sourcing for receipts from sales of other than tangible personal property.5 As a means to generate meaningful data that will be used in the Department's study, the Department is requiring all corporate taxpayers with more than $10 million in apportionable income and a North Carolina apportionment percentage of less than 100 percent based in whole or in part upon the sales factor, as reported on their 2014 North Carolina corporate tax returns, to file informational reports showing the calculation of the sales factor for the 2014 tax year using market-based sourcing.6

The report should be filed on Form NCDOR CD-400 MS, and includes the following information:

  • The corporation's 2014 apportionment percentage computed on the filed 2014 North Carolina corporate tax return.
  • The corporation's 2014 apportionment percentage computed based on the market-based sourcing provisions outlined in H.B. 97 and the model marketbased sourcing regulations drafted by the Multistate Tax Commission (MTC).
  • The corporation's primary industry code under the North American Industry Classification System (NAICS).7

The legislature has directed the Department to publish guidelines for computing the sales factor using market-based sourcing. The Department recently has published two documents clarifying the state's position regarding market-based sourcing principles and providing several examples.8 The following market-based sourcing principles will be applied:

  • The sale of real property, and the rental, lease or license of real property or tangible personal property is in North Carolina to the extent the property is located in North Carolina.
  • The sale of a service is in North Carolina if and to the extent the service is delivered to a location in North Carolina.
  • The rental, lease or license of intangible property is in North Carolina if and to the extent it is used in North Carolina. Intangible property utilized in marketing a good or service to a consumer is considered to be used in North Carolina if the consumer of that good or service is in North Carolina.
  • Intangible property that is sold is in North Carolina if and to the extent the property is used in North Carolina. A contract right, license, or similar intangible that authorizes a holder to conduct an activity in a specific geographic area is in North Carolina if the geographic area includes all or part of North Carolina. Sales of intangible property that are contingent on the productivity, use or disposition of the intangible property are treated as receipts from the rental, lease, or licensing of intangible property. All other receipts from a sale of intangible property are excluded from the sales factor numerator and denominator.9

The Department also is required to consider the draft model regulations contained in Section 17 of the Uniform Division of Income for Tax Purposes Act (UDITPA), as well as any other model apportionment statutes and regulations relating to allocation and apportionment of income that are consistent with the MTC's models (which are not inconsistent with the above market-based sourcing principles).10 The UDITPA model provides additional definitions for specific receipts or transactions and the use of reasonable approximation when the state of assignment cannot be determined. The model further provides for exclusion from the numerator and denominator when assignment cannot be reasonably approximated.11

The Department also clarified the informational reporting requirements for taxpayers filing a combined report in North Carolina.12 Under such circumstances, and provided the qualifying criteria are met, the reporting corporation should complete both the income and net worth portions of the information report. In addition, each subsidiary must also file an information report but complete only the net worth component.

The informational report cannot be extended and is due on April 15, 2016 for all taxpayers, regardless of whether they file tax returns on a calendar year or fiscal year basis.13 A penalty of $5,000 is assessed for failure to timely file the report, though such penalty may be reduced or waived by the Department.14

Commentary

The information reporting requirement resembles similar efforts in prior years by Maryland and Rhode Island with respect to potential unitary reporting, including significant penalties for failure to comply. While the information may provide the Department with valuable information in assessing the potential impact such a change might have on tax collections, the narrow focus on a selected group of taxpayers overlooks a significant portion of North Carolina filers, including pass-through entities. It is important to note that the provisions of this legislation only apply to certain entities taxed as corporations in North Carolina which have significant apportionable income but do not have a 100 percent apportionment factor.

The Department has issued two resources to assist taxpayers in applying North Carolina's positions on market-based sourcing. The first document is a general summary, including several tables covering common revenue streams and the applicable rule.15 The second document is quite lengthy at 53 pages, and provides significant detail and multiple examples for each scenario, which may prove useful for taxpayers with more complex transactions involving other than tangible personal property.16

Due to the potentially sizable penalty for noncompliance, it will be imperative not to overlook the informational reporting requirement for the 2015 filing season. Though the informational report cannot be extended, all required information should be readily available for most taxpayers as it is based upon the 2014 tax year return and apportionment data. All taxpayers and preparers are encouraged to review all North Carolina corporate returns filed for the 2014 tax year to confirm where additional marketbased sourcing reporting may be required.

The Department has left some ambiguity surrounding reporting requirements for taxpayers that filed multiple short-period returns in 2014, and for fiscal year taxpayers with a due date for the 2014 North Carolina income tax return occurring after the April 15, 2016 deadline has passed. Through an informal (and nonbinding) discussion with a representative at the Department, in these situations the Department recommends that taxpayers and preparers use professional judgment when completing the informational report to adopt a methodology which can be substantiated. Viable reporting options may include aggregating data from multiple 2014 returns, or using 2013 data in the instance where accurate 2014 data is not fully available. Additionally, the Department has clarified that the reporting requirement applies to any taxpayer who filed a final North Carolina corporate income tax return for the 2014 tax year.

At this time, Form NCDOR CD-400 MS is only available for download on the Department's Web site, and is currently not accessible via GoSystem tax software or BNA tax forms.

Footnotes

1. S.L. 2015-241 (H.B. 97). For further discussion, see GT SALT Alert: North Carolina Enacts Significant Income, Franchise and Sales Tax Legislation, Contingent Upon Further Legislative Action.

2. S.L. 2015-241, § 32.14A.(a), (b).

3. S.L. 2015-268 (H.B. 259).

4. S.L. 2015-241, § 32.14.(a)-(c).

5. N. C. GEN. STAT. § 105-130.4(l)(3); S.L. 2015-241, § 32.14A.(a).

6. S.L. 2015-268, § 32.14A.(a).

7. S.L. 2015-268, § 32.14A.(b)-(d).

8. Guidelines for Computing the Sales Factor Based on Market-Based Sourcing, North Carolina Department of Revenue, Jan. 26, 2016; Introduction and Summary-Guidelines for Computing the Sales Factor Based on Market-Based Sourcing, North Carolina Department of Revenue, Jan. 29, 2016.

9. S.L. 2015-268, § 32.14A.(b)(1).

10. S.L. 2015-268, § 32.14A.(b)(2), (3).

11. Multistate Tax Compact, Article IV, Sec. 17, Draft Regulations, Nov. 17, 2015.

12. Guidelines for Computing the Sales Factor Based on Market-Based Sourcing, North Carolina Department of Revenue, Jan. 26, 2016; Introduction and Summary-Guidelines for Computing the Sales Factor Based on Market-Based Sourcing, North Carolina Department of Revenue, Jan. 29, 2016.

13. S.L. 2015-268, § 32.14A.(e).

14. Id.

15. Introduction and Summary-Guidelines for Computing the Sales Factor Based on Market-Based Sourcing, North Carolina Department of Revenue, Jan. 29, 2016.

16. Guidelines for Computing the Sales Factor Based on Market-Based Sourcing, North Carolina Department of Revenue, Jan. 26, 2016.

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