Is Florida a Market-Based Sourcing State? It Depends.
While Florida regulations adopt the income-producing activity/cost-of-performance test, several recent letter rulings published by the Florida Department of Revenue (Department) proclaim that Florida is a “market-based sourcing state.” Fla Stat. Section 220.15 just vaguely provides that the sale must be “in th[e] state.” Florida’s regulations clearly state the income-producing activity/greater cost-of-performance method is to be applied. Notwithstanding this regulatory clarity, the actual sourcing of services income to Florida remains a mystery.
The Department’s latest rulings seem to interpret income-producing activity as the last transaction in the entire process. In Fla. Tech. Assistance Advisement No. 20C1-001, Fla. Dept. of Rev., (Jan. 13, 2020), the Department determined the income-producing activity for the user fees is for access and purchases, which occurs where the customer is located. Thus, the Department concluded that such sales should be sourced based on the user’s billing address.
Florida defines income-producing activity as “the transaction and activity directly engaged in by the taxpayer for the ultimate purpose of obtaining gains or profits.” The regulations further define the term “costs of performance” as “direct costs determined in a manner consistent with generally accepted accounting principles and in accordance with accepted conditions or practices in the taxpayer’s trade or business. Where independent contractors are used to complete a contract, the term ‘costs of performance’ will include amounts paid to the independent contractors.” The Department seems to interpret “ultimate” to exclude most to all activities before the final transaction with the customer. By making a temporal distinction, the Department only considers activities after a transaction occurs with the customer.
Historically, most service providers entered contracts before performing a service, e.g., architectural services. If the income-producing activity crossed state lines, the cost of performance was relatively simple to ascertain (usually a measure of time expended to perform the service). But, under the Department’s interpretation, if the ultimate transaction crosses state lines and all the activity has occurred, how would the cost-of-performance test apply if there are no costs? The taxpayer would incur no “direct” costs. There would essentially be a tie between the state of origin and the state of destination. As services have become more commodified over time, it follows that their sourcing should track that of tangible personal property. The Department bolsters the destination claim by policy and legislative history. For more information regarding Florida’s sales factor, read this recent BKD Thoughtware® article.
Nonetheless, for service providers that enter into contracts before the performance of the service, the income-producing activity/cost-of-performance method may still be viable. Every taxpayer’s facts and circumstances must be carefully evaluated.
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