Market-Based Apportionment

Nick NiemannMcGrath North Mullin & Kratz, PC LLO

Omaha, NE

Sale of TPP

Initially• 3 factors

– Property– Payroll– Sales

Trend• Single factor• Some combination of

1-3 factors– Single, double or triple

weighting

Sale of Services

Initially• Cost of Performance

– Cliff (All-or-Nothing)

Trend• Cost of Performance

– Percentage

• Market-State

Apportionment Nationally

DRAMATIC EFFECT OF NEBRASKA’S PRESENT INCOME APPORTIONMENT RULE

Company Facts:· Service Provider Operating In Nebraska and Iowa· Company Costs of Performance (Facilities and Employees): 49% Nebraska; 51% Iowa· Customer Locations: 49% Nebraska; 51% Iowa

Question: How Should The Company Income Be Divided (Apportioned) Between Nebraska And Iowa?

DRAMATIC EFFECT OF NEBRASKA’S PRESENT INCOME APPORTIONMENT RULE

Company Facts:· Service Provider Operating In Nebraska and Iowa· Company Costs of Performance (Facilities and Employees): 51% Nebraska; 49% Iowa· Customer Locations: 51% Nebraska; 49% Iowa

Without LB 872(Cost of Performance Rule)

Question: How Should The Company Income Be Divided (Apportioned) Between Nebraska And Iowa?

Cost of Performance Rule

Result:Taxed On 100% of Income Result:

Taxed On 49% of Income

Market-State Rule

With LB 872(Market-State Rule)

TotalTaxed on149% of Income

Example #1

+ =

Market-State Rule

Result:Taxed On 51% of Income Result:

Taxed On 49% of Income

Market-State Rule

TotalTaxed on100% of Income

+ =

Without LB 872(Cost of Performance Rule)

Cost of Performance Rule

Result:Taxed On 0% of Income Result:

Taxed On 51% of Income

Market-State Rule

With LB 872(Market-State Rule)

TotalTaxed on

51% of Income

+ =

Market-State Rule

Result:Taxed On 49% of Income Result:

Taxed On 51% of Income

Market-State Rule

TotalTaxed on100% of Income

+ =

Example #2

DRAMATIC EFFECT OF NEBRASKA’S PRESENT INCOME APPORTIONMENT RULE

Company Facts:· Service Provider Operating In Nebraska and Iowa· Company Costs of Performance (Facilities and Employees): 49% Nebraska; 51% Iowa· Customer Locations: 49% Nebraska; 51% Iowa

Question: How Should The Company Income Be Divided (Apportioned) Between Nebraska And Iowa?

DRAMATIC EFFECT OF NEBRASKA’S PRESENT INCOME APPORTIONMENT RULE

Company Facts:· Service Provider Operating In Nebraska and Iowa· Company Costs of Performance (Facilities and Employees): 51% Nebraska; 49% Iowa· Customer Locations: 51% Nebraska; 49% Iowa

Without LB 872(Cost of Performance Rule)

Question: How Should The Company Income Be Divided (Apportioned) Between Nebraska And Iowa?

Cost of Performance Rule

Result:Taxed On 100% of Income Result:

Taxed On 49% of Income

Market-State Rule

With LB 872(Market-State Rule)

TotalTaxed on149% of Income

Example #1

+ =

Market-State Rule

Result:Taxed On 51% of Income Result:

Taxed On 49% of Income

Market-State Rule

TotalTaxed on100% of Income

+ =

Without LB 872(Cost of Performance Rule)

Cost of Performance Rule

Result:Taxed On 0% of Income Result:

Taxed On 51% of Income

Market-State Rule

With LB 872(Market-State Rule)

TotalTaxed on51% of Income

+ =

Market-State Rule

Result:Taxed On 49% of Income Result:

Taxed On 51% of Income

Market-State Rule

TotalTaxed on100% of Income

+ =

Example #2

COP – Cliff (All-or-Nothing)

COP - Percentage

Market-sourcing approach

No Income Tax

OtherNote: Year shown = States enacting market-state in past 10 years.

Sales Factor: Sourcing of Services

2011

2009

2010

2009

2007

2003

2007

2011 2005

2009

Phase-In2014-2017

Effective2014

TPP• 1967: 3 factor• 1987: Single factor (Sales)

– LB 772: Phase In (1988-1992)

– LB 775: Immediate for Nebraska incentive package

Services• 1967: COP – Cliff• 2012 Single factor (Sales) - LB 872: Market-State (Eff. 1-1-14)

Nebraska’s Apportionment Rule

History

Nebraska Market-State Rules

In NE If Buyer Uses SaaS In NE

Individual Customers:Billing Address In NE

Business Customers:Uses In Regular Course Of

Business In NE

2. Application Service (SaaS)

Use In Multiple States:% Use In NE

% Use In Everywhere

B) Application Service(SaaS)

Use In Nebraska:If Buyers, from Neb. location,

Use SaaS in the regular course of business

Individual:Billing Address Is In NE

Apportionment For Business Entity:If use in more than one state,

apportion based on proportion of use in Neb. vs. other states

If Location Of Sale Can’t Be Determined:

State From Which Order Was Placed(If that office cannot be determined,

then Customer’s Billing Address)

OR

AND

AND

Apportioned To NE IfDerived From Buyer In NE

Services On Real Property:Property in NE

Services On Tangible Personal Property:

TPP in NE at the time the service is rendered;

Individual Customers:Individual Physically

Present In NE

Business Customers:1) Buyer Engaged In Business In

NE; and 2) Relates To That Part Of The

Business Operated In NE

1. Apportionment of Services

Use In Multiple States: Use In NE

% Use In Everywhere

If Location Cannot Be Determined:State From Which Order Was Placed

(If Indeterminable, Customer’s Billing Address)

In NE If Buyer Uses SaaS In NE

Individual Customers:Billing Address In NE

Business Customers:Uses In Regular Course Of

Business In NE

2. Application Service (SaaS)

Use In Multiple States:% Use In NE

% Use In Everywhere

B) Application Service(SaaS)

Use In Nebraska:If Buyers, from Neb. location,

Use SaaS in the regular course of business

Individual:Billing Address Is In NE

Apportionment For Business Entity:If use in more than one state,

apportion based on proportion of use in Neb. vs. other states

If Location Of Sale Can’t Be Determined:

State From Which Order Was Placed(If that office cannot be determined,

then Customer’s Billing Address)

OR

AND

AND

Apportioned To NE IfDerived From Buyer In NE

Services On Real Property:Property in NE

Services On Tangible Personal Property:

TPP in NE at the time the service is rendered;

Individual Customers:Individual Physically

Present In NE

Business Customers:1) Buyer Engaged In Business In

NE; and 2) Relates To That Part Of The

Business Operated In NE

1. Apportionment of Services

Use In Multiple States: Use In NE

% Use In Everywhere

If Location Cannot Be Determined:State From Which Order Was Placed

(If Indeterminable, Customer’s Billing Address)

Nebraska Market-State Rules• Sale of Intangibles: . . . . . . . • Treasury Function: . . . . . .

Loan: . . . . . . . . . . . . . . . . . .

• Credit Card: . . . . . . . . . . . . .• Lease or License of TPP: . . . • Sale, Lease or License of

Real Property: . . . . . . . . . . .• Other Sales: . . . . . . . . . . . .

• Telecom Companies: . . . . .

Location of UseExtent of ManagementLocation of Security or Debtor’s AddressBilling AddressProperty Location

Property LocationExtent of NE Business Activity

Keep COP - Cliff

Market-State for Services- Tax Perspective -

Pros

• In-state service providers– Avoid >100% taxation– No tax penalty for engaging in

a service

• Less TPP v. Service controversies

• Less “Income-producing activity” controversies

• No more COP interpretation issues

Cons

• Increases taxable jurisdictions for out-of-state service providers

• More nexus enforcement• Multiple Market Based Sourcing

tests• Retaining / obtaining user or

customer information– Benefits received

• Cost of compliance• Introduces new sourcing

interpretation issues

Market-State for Services- Economic Development Perspective -

Pros Cons

• Certain in-State companies may prefer COP – Cliff if results in -0- tax

• May cause some out-of-state service providers to not make services available to in-State customers

• No tax penalty for having jobs and capital investment in the taxing State

• Puts emphasis on exporting services (and importing revenue) using in-State employees and capital investment

Market-Based Apportionment

Thank You

Nick Niemann

Nick Niemann• Partner - McGrath North Law Firm• Member - American & Nebraska Bar Association

- American Institute & Nebraska Society of CPA’s- Council On State Taxation (Practitioner)

• Creighton - College of Business 1978 (Summa Cum Laude)- School of Law 1981 (Magna Cum Laude)

- Adjunct Faculty – State Tax • Best Lawyers In America (Tax Law and Litigation & Controversy – Tax)• Principal designer and drafter of most of Nebraska’s economic development tax incentive

programs (e.g., 1987’s LB775 Employment and Investment Growth Act and 2005’s LB312 Nebraska Advantage Programs, the Nebraska capital gains exclusion and the single factor corporate apportionment formula).

• Nick works with company tax department personnel and their outside CPA firms and/or legal counsel, to address site selection, state tax planning opportunities, tax audits and appeals, refund claims and appeals, and tax and other incentives.

• Contact Info: nniemann@McGrathNorth.com Website: www.McGrathNorth.com

(402) 633-1489Nick’s partner, Matt Ottemann, of McGrath North assisted in the creation of this presentation.

Market-Based ApportionmentPresentation Disclaimer

Disclaimer•This presentation should not be considered as legal, tax, business or financial advice. This presentation is designed to provide information about the subject matter covered. It is provided with the understanding that while the speaker/author is a practicing state tax and incentive advisor, neither he nor his firm has been engaged by the attendee/reader to render legal or other professional services (unless a specific engagement agreement has been executed). If legal advice or other expert assistance is required by the attendee/reader, the services of a competent professional should be sought.

Circular 230 Disclosure•The following statement is required by the U.S. Treasury Department Regulations: Any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed here.