As we reported on Friday, the Massachusetts Department of Revenue has promulgated its final regulations governing the apportionment of income (830 CMR 63.38.1).  The regulations implement legislation that mandates market-based sourcing and a throwout rule for sales other than sales of tangible personal property, effective for tax years beginning on or after January 1, 2014.

The final version of the regulations closely resembles the second draft of the proposed regulations issued by the Department last Fall, but there are a few notable differences:

830 CMR 63.38.1(9)(d)1.e.ii.  Approximation Based Upon Known Sales:

The regulation provides several safe harbors and rules of approximation for sourcing receipts when the market for a particular customer is not apparent or known to the taxpayer.  The final regulations improve upon these rules by permitting professional service providers the same ability to source “unknown sales” (sales where the taxpayer cannot determine the state of assignment) based on the sourcing method used for “known sales” (sales where the taxpayer can determine the state of assignment).

  • Old Rule:  Unlike most other service providers covered by the regulation, professional service providers are prohibited from sourcing unknown sales based on the geographic location of known sales.
  • New Rule: The final rule harmonizes the treatment of professional services with other types of services, permitting the use of reasonable approximation to source unknown sales based on the geographic location of known sales.
830 CMR 63.38.1(9)(d)4.c.ii(B)2.d; (d)4.d.iii.(A)3Safe Harbors for Sourcing Receipts—Professional Services and Services Delivered Electronically to Business Customers:

The draft regulations contained “safe harbor” provisions allowing certain taxpayers to source professional service receipts and receipts from services delivered electronically based on billing address, regardless of where the services were actually delivered.  The new rules have lessened the burden taxpayers must meet to qualify for the safe harbor.

  • Old Rule: A taxpayer may source receipts based on a customer’s billing address if: (1) the taxpayer provides substantially similar services to over 1,000 customers; and (2) the taxpayer does not derive more than 5% of its sales from the customer.
  • New Rule:  A taxpayer may source receipts based on a customer’s billing address if: (1) the taxpayer provides substantially similar services to over 250 customers; and (2) the taxpayer does not derive more than 5% of its sales from the customer.
830 CMR 63.38.1(9)(d)1.g.  Changes in Methodology; Commissioner Review:

In our view, one of the most concerning aspects of the regulation is the Department’s provision that severely restricts taxpayer’s ability to file refund claims or offset assessments by changing their method for reasonably approximating receipts sourced to Massachusetts.  (It is our view that this portion of the regulation exceeds the Department’s authority and is invalid.)  Several comments challenging this restriction were submitted to the Department, but it unfortunately remains in the final promulgated rules.

In addition to the harsh restrictions on the filing of refund claims by taxpayers, the Department’s draft regulations preserved the Department’s authority to audit and assess additional tax based on adjustments to the taxpayer’s method for reasonably approximating receipts sourced to Massachusetts in five circumstances.  The final regulations now add a sixth circumstance in which the Department can make an adjustment to the taxpayer’s method of reasonably approximating receipts sourced to Massachusetts.

  • Old Rule: The Commissioner may adjust a taxpayer’s return to more accurately assign sales in the following circumstances:
  1. In any case in which the taxpayer fails to properly assign sales in accordance with the rules set forth in the regulations;
  2. In any case in which a taxpayer uses a method of approximation to assign its sales and the Commissioner determines that the method of approximation employed by the taxpayer is not reasonable;
  3. In any case in which the Commissioner determines that the taxpayer’s method of approximation is reasonable, but has not been applied consistently;
  4. In any case in which a taxpayer excludes sales from its sales factor because it determines that the assignment of those sales cannot be reasonably approximated, but the Commissioner determines that those sales can be reasonably approximated;
  5. In any case in which the taxpayer fails to retain contemporaneous records that explain the determination and application of its method of assigning its sales, or fails to provide these records upon the Commissioner’s request.
  • New Rule:  The final regulations add a sixth circumstance:

6.  In any case in which the Commissioner concludes that a taxpayer sourced a sale according to its customer’s billing address for the purpose of tax avoidance.

830 CMR 63.38.1(9)(d)4.b.iii.  Transportation and Delivery Services:

The final regulations contain several additions and alterations to the draft rules for sourcing receipts from transporting people and delivering goods.

  • Old Rule: There were separate rules for sourcing two types of transportation and delivery services: (1) services provided by air; and (2) services provided by means other than by air.  This created an ambiguity regarding the treatment of taxpayers who delivered property by both air and other methods.
  • New Rule: The rule has been revised to clarify that transportation and/or delivery services receipts can be derived from: (1) services provided exclusively by air; and (2) services provided by means other than exclusively by air.  If a taxpayer provides transportation and delivery services both by air and another method, the taxpayer sources its receipts following the rules for transportation and delivery services performed by means other than exclusively by air.

 

  • Old Rule:  While receipts from transportation and delivery companies (other than air transportation and delivery companies) were sourced based on the percentage of “pickups” and “deliveries” in Massachusetts, those terms were not defined.
  • New Rule: The terms “pickup” and “delivery” are now defined.
  • Pickup: The location at which an item of tangible personal property is transferred from the customer (or its designee) for transportation and subsequent delivery.
  • Delivery: The location at which an item of tangible personal property that has been transported is transferred to the customer (or its designee).

 

  • Old Rule:  The regulation was silent on the treatment of receipts from transportation or delivery services where the services were sold by one entity, but then the actual services were performed by an affiliated entity.
  •  New Rule:  Receipts from a taxpayer’s sale of transportation and delivery services are assigned pursuant to the rules governing these services if they are provided directly by the taxpayer or indirectly by another entity under common ownership with the taxpayer.