United States

Indiana: Department Addresses Application of Income-Producing Activity Test; Reaches Market-Based Result

Feb 09, 2015
From KPMG TaxWatch

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Recently, the Indiana Department of Revenue issued a new Letter of Findings that sheds some light on how the Department interprets the statutory income-producing activity test for sourcing receipts from sales of other than tangible personal property. The taxpayer at issue provided online educational courses to students all over the country, including in Indiana. Costs related to overhead, online course development and IT were all incurred outside of Indiana. The taxpayer had faculty in a number of states, potentially including Indiana, but no in-person courses were taught in Indiana. The taxpayer took the position that because most, if not all, of its costs were incurred out-of-state where its courses were developed and IT maintained, none of the receipts were attributed to Indiana under the state’s income-producing activity test. An auditor disagreed with this conclusion and the matter eventually went to a departmental hearing.

Under Indiana law, sales other than sales of tangible personal property are sourced to Indiana if the income-producing activity is performed in Indiana or the income-producing activity is performed both within and without Indiana and a greater proportion of the income-producing activity is performed in Indiana than in any other state, based on costs of performance. The relevant regulations provide that the “income producing activity” means the act or acts directly engaged in by the taxpayer for the ultimate purpose of obtaining gains or profit. In addressing the application of the income-producing activity test to the taxpayer’s services, the hearing officer noted that the Department does not typically reach the costs of performance issue because it only seeks to include in the Indiana numerator monies earned from income-producing activities performed in Indiana. In the Department’s view, the taxpayer's "income producing activity" associated with its services was performed entirely in Indiana because "the act or acts directly engaged in by the taxpayer for the ultimate purpose of obtaining gains or profit" occurred in Indiana. The taxpayer, the hearing officer concluded, did not earn money from hiring or training its faculty members, developing online courses, or incurring local overhead expenses. Rather, the taxpayer’s income resulted from selling online educational services to Indiana customers and under the income-producing activity test (as applied by the auditor) these receipts were properly includable in the Indiana sales factor numerator. The hearing officer concluded by reiterating that the costs of performance test is only relevant if the Department is attempting to apportion income-producing activities performed both within and without Indiana. Although the taxpayer lost the substantive issue, the hearing officer agreed to waive the underpayment penalty for reasonable cause. Please contact Marc Caito 317-951-2434 with questions on Indiana Letter of Findings No. 02-20140455.

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.