CPAs need to be aware of current developments in key states in order to properly advise taxpayers doing business in multiple jurisdictions. Particularly of note are the recent apportionment changes in Connecticut.
On April 18, 2017, the Connecticut Department of Revenue Service (DRS) issued Special Notice 2017(1), which provides guidance on the recent apportionment changes applicable to corporate and individual taxpayers. The notice addresses the sourcing of receipts from the sale of services and the rental, lease, or license of intangible property, as well as when certain receipts are to be excluded from sales altogether. Generally, under the market-based sourcing rules, receipts are sourced to Connecticut to the extent the service or intangible is used within the state. For both services and intangibles, the sourcing rules vary depending upon the type of customer (business versus individual).
Sourcing Rules for Services
Receipts from the sale of services to business customers are sourced to Connecticut based on a tiered approach, under which a taxpayer utilizes the first usable sourcing methodology in the following list, starting from the top:
- Books and records—source the sale to Connecticut if the customer contract or taxpayer’s books and records reflect that the service was used in the state
- Reasonable approximation—reasonably approximate the location where the service is used
- Order from—source the sale to the location from which the customer placed the order
- Bill to—source the revenue to the customer’s billing address.
Determination of the location from which services to individual customers are used is based on the type of service provided. Receipts from services related to real or tangible personal property are sourced to Connecticut if the property is located in or delivered to Connecticut. Receipts from services that require the physical presence of the customer (e.g., haircuts, physical therapy) are sourced to Connecticut if the service is performed in Connecticut. Receipts from all other services are generally presumed used in Connecticut if the customer’s billing address is in Connecticut; however, subject to DRS scrutiny, a taxpayer may use the sourcing method specified in a customer contract or as reported in the taxpayer’s books and records instead of the “bill to” method, if such method reasonably reflects where the service is used.
Sourcing Rules for Intangibles
The sourcing of receipts from the rental, lease, or license of intangible property to business customers is based on the location in which the intangible is used. Determining the location from which an intangible is used involves the same four-tier rule as sourcing service receipts from business customers. This is the rule for both marketing intangibles (e.g., trademarks, trade names) and non-marketing intangibles (e.g., patents); where a contract involves the use of both (i.e., mixed intangibles), the fees associated with each intangible should be sourced separately, according to the four-tier rule, so long as the fee for each intangible is separately stated in the contract. To the extent that the fee for each intangible is not separately stated in the contract, however, all fees are presumed to be from the use of the marketing intangible and must be sourced accordingly.
Receipts from the rental, lease, or license of intangible property to individual customers are sourced to Connecticut to the extent the intangible is used in Connecticut. Intangible property is presumed used in Connecticut if the individual customer’s billing address is in Connecticut; however, receipts may instead be sourced according to a customer contract, or as reported in the taxpayer’s books and records if such method reasonably reflects where the intangible is used.
Market-based Sourcing—Additional Information
Taxpayers unable to determine proper sourcing of receipts under the market-based rule may petition the DRS for an alternative basis. Procedures for making a petition are set forth in Special Notice 2017(1).
Other Apportionment Rules
Taxpayers required to use industry-specific apportionment rules (i.e., air carriers, financial service companies, securities brokerage services) must continue using the industry-specific apportionment rules and are not affected by the new market-based sourcing rules.
For both corporate and individual taxpayers, certain receipts from real property, tangible personal property, and intangible property are excluded from the sales factor if the property is not held by the taxpayer for sale in the ordinary course of business. Whether gain or loss from these items is included in apportionable net income or allocated depends upon the type of taxpayer and use of the property.
Under Connecticut’s new apportionment rules, corporate taxpayers are required to use a single–sales factor apportionment formula as well as the aforementioned apportionment rules for tax years beginning on or after January 1, 2016; the rules apply to individual taxpayers for tax years beginning on or after January 1, 2017.