Aug 17, 2015
From KPMG TaxWatch
The Colorado Department of Revenue (Department) recently ruled that a purchaser of defaulted accounts receivables must apportion its income under the rules for sourcing service income. The taxpayer’s primary business was acquiring, managing, and collecting on charged-off consumer and commercial accounts receivables. These receivables, which had been charged-off as bad debts, but remained subject to collection, were purchased from financial institutions, finance and leasing companies, and other issuers. The taxpayer utilized affiliated law firms and third-party debt collection companies located around the country to assist in collecting. Historically, the taxpayer apportioned almost 100 percent of its receipts to Colorado, its commercial domicile, based on its determination that its receipts were most akin to gains realized on the sale of intangibles or the receipt of interest income. After accumulating significant net operating losses, the taxpayer submitted a ruling request to the Department seeking a change in its apportionment approach. The taxpayer believed that the best approach would be for it to utilize the special apportionment rule for financial institutions and requested a ruling from the Department to this effect.
The Department first concluded that the taxpayer did not qualify as a financial institution. Financial institutions earn income by providing financial services such as investment advice, loaning funds, and accepting deposits. The taxpayer, on the other hand, did not provide financial services, but purchased charged-off financial services in the form of loans and earned income by collecting on the purchased debts. Although financial institutions also collect on loans, in the Department’s view this did not automatically qualify the taxpayer as a financial institution. Furthermore, the taxpayer was not registered as a bank or other type of financial institution under federal or state law and did not meet the definition of a financial institution in Colorado’s regulations.
The Department next addressed how the taxpayer’s receipts should be characterized for apportionment purposes. Under Colorado law, there were three sourcing rules that could potentially apply. The first applied to gain or loss from the sale of intangibles; the second applied to interest income; and the third was the rule for sourcing service receipts. In the Department’s view, the taxpayer’s income was not gain from the sale of intangibles because the taxpayer purchased intangibles, but did not sell them. The Department also determined that the rules for sourcing interest income did not apply. Although some of the taxpayer’s collected debts represented interest, the majority of its income was generated from the payment of principal. This left the rule for service receipts. The Department acknowledged that characterizing the company as a service provider was unusual because service providers typically sell services to third parties, and here the taxpayer was actually consuming or using the service to generate income. Nonetheless, the Department determined that the sourcing rule for service receipts best applied to the taxpayer’s business. As such, it concluded that the taxpayer should source its receipts based on where the costs to perform the services occurred. The Department also reasoned that the company was in essence providing a “service” to financial institutions by purchasing their bad debts. For more information on this private letter ruling, please contact Mark Kaye at 303-382-7855.
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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.