Mississippi is an “all or nothing” state when it comes to designating the source of taxing the revenue a multistate corporation makes through the sales of services.
Here’s an explanation from attorney Richard Henchman, VP of legal & sate projects for The Tax Foundation, based in Washington, D.C.: “The historical approach is Cost of Performance (CoP), or Income-Producing Activity (IPA). Under this rule, sale of services are sourced to the state where most of the activity occurs/costs were borne. It’s an all-or-nothing rule, which means little changes can make a big difference. Take Nebraska, which had this rule until recently. A Nebraska service provider that sells 51 percent of its services to customers in Nebraska and 49 percent to customers in Iowa will have 100 percent of their service sales apportioned to Nebraska, because a majority — 51 percent — of the costs providing the services are borne in Nebraska.”
The Mississippi Department of Revenue decided a couple years ago to try a new approach — Market-Based Sourcing, or Benefits — after reviewing tax returns from Atlanta’s Equifax Credit Information Services. With this approach, The Tax Foundation’s Henchman said in an email, sales of services are sourced in proportion to where they are provided.
“Take Iowa, which has this rule. The Nebraska service provider that provides 49 percent of its services to Iowa will have 49 percent of its sales sourced to Iowa. (Taking the two examples together, this company will be taxed on 149 percent of its profits — 100 percent sourced to Nebraska and 49 percent sourced to Iowa. Reverse examples also occur.)”
The DOR’s selection of Equifax caused the company’s tax bill to go from zero to more than $700,000. The DOR switched to the new standard after concluding the state’s statutory standard would not fairly reflect Equifax’s business activity in Mississippi, which consisted of providing credit reporting services electronically to Mississippi businesses. Equifax sued, losing in Chancery Court, winning in appeals court but losing last summer at the Mississippi Supreme Court, which held that the DOR could apply a tax to the actual revenue Equifax made in Mississippi. Equifax has since filed a notice with the state’s high court that it will seek a U.S. Supreme Court review of the finding that Equifax had to show why the market standard would not fairly reflect its business activity in the state.
Henchman said the increasing reliance on the sales factor in tax apportionment means greater attention to how states source sale of services. Achieving this is easier said than done, he noted.
“Defining what counts is still being developed state-by-state, with much complexity and non-uniformity.” In addressing apportionment in general,” Henchman said frustration with the states’ patchwork of standards and rules on taxation of multistate companies led Congress in the 1950s to threaten to settle the issue of the amount of a corporation’s profit that could be subject to tax by each state. To head off such a move, the states banded together and came up with the Uniform Division of Income for Tax Purposes model Act (UDITPA), which enshrined an evenly-weighted three-factor formula: one-third based on property, one-third based on payroll, one-third based on sales. As an example, a Mississippi company with 50 percent of its payroll in Mississippi, 50 percent of its property in Mississippi, but, say, only 2 percent of its sales in the state would have an average of 34 percent for these three items, Henchman explained.
“So only 34 percent of their profits are subject to Mississippi tax under the three-factor formula.” Some states such as Iowa prefer a “single-sales” factor. “All that mattered for corporate tax apportionment for them was where sales were,” Henchman said.
For instance, a multistate company with lots of property or employees in Iowa but few sales in Iowa would pay very little tax to Iowa. But multistate corporations with no presence in Iowa except for sales would have to pay a lot more tax to Iowa, he added.
The U.S. Supreme Court upheld Iowa’s single-sales factor approach in 1978, leading other states to begin copying Iowa. The result: UDITPA today is no longer uniform, Henchman said. “Most states now double-weight or exclusively weight sales for corporate tax apportionment,” he added. “The current dis-uniformity, aside from creating needless complexity and causing multiple taxation, has also given rise to the problem of nowhere income — income left untaxed because the state that ought to tax it isn’t taxing it.”