A plain reading of the Florida rules indicates that revenue from the sale of other than tangible personal property should be based on the greater cost of performance. In the early 2000s, however, the FL DOR began to permit the use of market or customer-based sourcing on a case-by-case basis. Today, the FL DOR has come full circle and started proactively looking to apply market sourcing. It is questionable whether the state courts agree with the FL DOR’s tactical change, leaving taxpayers in sourcing limbo.
The Birth of Market-Based Sourcing in Florida
The Florida regulations generally require the sales of other than tangible personal property (other sales) to be sourced to Florida when the “greater proportion of the income producing activity is performed in Florida, based on costs of performance” [Fla. Admin. Code Ann. section 12C-1.1055(e)(2) (l)]. Income-producing activity is defined as “each separate item of income and means the transactions and activity directly engaged in by the taxpayer for the ultimate purpose of obtaining gains or profits” [Fla. Admin. Code Ann. section 12C-1.1055(e)(2)(l)]. Historically, this rule has been interpreted as a greater cost of performance (COP) sourcing rule. But taxpayers started to reject the COP rule and tried to reinvent Florida’s sourcing regime based on the location of customers approximately ten years ago. Thereafter, the FL DOR began issuing Technical Assistance Advisements creating a market-based sourcing rule premised on an interpretation that both the transaction and activity can only occur in Florida when the customer is located in Florida, seemingly conceding that the taxpayers’ interpretation was reasonable [see Florida Technical Assistance Advisement 13C1-011, 11/21/2013]. Hence, the birth of Florida’s market-based sourcing rules. Over the next decade, the FL DOR continued to allow market-based sourcing on a case-by-case basis.
The FL DOR Tries to Level the Playing Field
In 2022, the FL DOR sought to interpret the sourcing rules by applying market-based sourcing to Target’s intercompany sales. In Target Enterprise v. Department of Revenue [Circuit Court 2nd Dist., Leon County, No. 2021 CA 002158 (11/28/22)], Target Enterprise, Inc. (TEI), a Minnesota subsidiary of the Target Corporation (Target) with no employees in Florida, applied the COP rules to source all of its intercompany sales outside of Florida. The FL DOR rejected TEI’s use of COP. In this case, TEI was providing Target with various intercompany services for which Target paid an arm’s length fee. The FL DOR applied market-sourcing to these other sales. While the court did not state that FL DOR was entirely erroneous in its application of market-based sourcing, it did balk at FL DOR’s attempt to use the square footage of the Target retail stores in Florida as proxy for TEI’s costs of performance. The court denied this position, stating that the approach “conflates Target’s business activity in Florida with TEI’s business activity,” and that the sourcing under the Florida rules should consider where the taxpayer’s COP takes place, not where its customer does business. The court suggested that TEI’s payroll factor would provide the best approximation for this cost of performance. Although the court rejected the FL DOR’s use of market-sourcing in this case, the opinion did not clearly state that COP is the law of the land in Florida.
In 2023, the circuit court clarified that its rejection of market-sourcing in the Target case was not an anomaly. In Billmatrix Corp. et. al v. Florida Department of Revenue [Circuit Court 2nd Dist., Leon County, No. 2020 CA 000435 (3/1/23)], the court clearly stated that the plain language of the Florida regulations “unambiguously directs that the income from Plaintiffs’ sales be determined through the use of the cost of performance methodology.” The court further stated that the FL DOR’s inconsistent interpretation of the regulations was a violation of the Taxpayer’s Bill of Rights, which guarantees the “right to fair and consistent application of the tax laws of this state by the Florida Department of Revenue.” In the Billmatrix case, the court did not mince words when explaining that the FL DOR had overstepped its bounds by applying market-based sourcing in lieu of COP. Although the circuit court has made its position clear, the Billmatrix case remains in the appeals process, leaving taxpayers with the ability to continue using market-based sourcing, at least for the moment.
Special Industries Push Back on the Sourcing Rules
The FL DOR’s sourcing issues do not end with the basic sourcing methodologies. Special industries have put forth their own interpretation of the rules. JetBlue Airways recently filed suit against the FL DOR, alleging that Florida’s sourcing methodology exceeds the state’s constitutional boundaries and violates the Commerce and Due Process Clauses of the United States Constitution [see JetBlue Airways Corporation and Subsidiaries v. Florida Department of Revenue, Circuit Court 2nd Dist., Leon County, No. 2024 CA 001177 (7/19/2024)]. Sourcing for commercial airlines is based upon per passenger revenue miles flown within the state, including “all miles traversed between points in this state, even though the route of travel is not wholly over the land mass of the state.” [Fla. Stat. section 220.151(2)(a), (c)]. JetBlue contended that the inclusion of miles outside of Florida’s land mass reaches beyond the state’s constitutional jurisdiction. The JetBlue case highlights the uncertainty of Florida’s current sourcing methodologies, uncertainty that even goes beyond the ordinary arguments.
As each of these cases continue to move through the judicial process, taxpayers are left in a perplexing—but not necessarily disadvantageous—position. The FL DOR has seemingly approved market-based sourcing interpretations for over a decade. Although the circuit court indicated that such interpretations do not follow the plain language of the regulations, the cases are in litigation, leaving open opportunities around sourcing. Taxpayers may continue to use either sourcing methodology, but they need to weigh the risks and rewards that accompany each methodology. The recent cases could be stuck in the judicial process for years; therefore, taxpayers and their advisors should also consider the application of the statutes of limitations and the potential to file protective refund claims.
It is critical that CPAs understand the complexity of Florida’s sourcing rules in order to continue to advise clients accordingly, at least until the FL DOR and the Florida courts can come to agreement on the state’s sourcing of revenue from “other than tangible personal property.”
