Feb 29, 2016
From KPMG TaxWatch
The FTB Chief Counsel was recently asked to address the application of the state’s market-based sourcing rules to a service provider’s business. The resulting Chief Counsel’s ruling was recently published by Tax Analyst’s, but is not currently posted on the FTB’s website. The service provider at issue was engaged in the business of providing integrated financial information and analytical applications to business entity customers. The taxpayer’s customers in turn provided financial services to their business entity customers. In the taxpayer’s situation, both its customers and its customers’ customers received the benefit of its services. Thus, the question posed to the FTB was whether the taxpayer should source its receipts to the location where its customers received the benefit of the services, or to the location where its customers’ customers received the benefit.
The FTB noted that in certain situations, the location where the benefit of services received may actually be the location of the taxpayer’s customers’ customers. However, the statute and regulations do not specify when a taxpayer should “look-through” to its customers’ customers’ locations to assign the sale of a service. However, the FTB noted that the regulations for sourcing receipts from sales of intangibles provided some insight. Specifically, regulation 25136-2(d)(2) makes a distinction between a "marketing" and "non-marketing" intangibles. A marketing intangible is sourced to the location of the ultimate consumer, but a non-marketing intangible is sourced to the location where the customer uses the intangible in its business. Applying the guidance assigning sales of "non-marketing" intangibles to sales of "non-marketing" services, the FTB concluded that sales from the taxpayer’s services would be sourced to the location where the taxpayer's customer received a benefit of the service through the use in the customer’s business. The FTB stated that “the value of a non-marketing service lies not in the advertising or promoting of a product, service or other item, but rather the value lies in the service being used in the business operations of the taxpayer's customer.”
In determining where the benefit of a service is received, California’s regulations provide that the benefit of a service is presumed to be received in California to the extent the contract between the taxpayer and the taxpayer's customer or the taxpayer's books and records kept in the regular course of business, notwithstanding the billing address of the taxpayer's customer, indicate the benefit of the service is received in California. The taxpayer requested that, in lieu of financial information kept in its books and records, it be allowed to use processing power or CPU data as a reasonable proxy for financial data. The CPU data allowed the taxpayer to measure each customer's relative CPU usage at various work locations. The FTB concluded that where, as here, the taxpayer could not reasonably extrapolate financial data to determine the location and extent of the benefit of the service received by the taxpayer's customers in California, sourcing the receipts based on CPU usage was an acceptable proxy. Please stay tuned to TWIST for future updates on this ruling.
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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.