Sales Factor: Other Than Tangible

Written by Gregory Fallon, EA, MST on Friday, 30 August 2013.

Sales Factor: Other Than Tangible

When it comes to apportionment the sales factor is usually the most influential factor.  Many states double weight the sales factor and some have adopted a single sales factor apportionment formula.  There is a growing philosophy that by using payroll and property factors for apportionment states are encouraging businesses to build plants and employ workers out of state. 

The complexity of the sales factor is mainly due to the lack of uniform sourcing rules.   In the past, for the most part, sales of services and other then tangible property (OTTP) were sourced based on income-producing activity. If the taxpayer conducted income-producing activities in multiple states the sales were either apportion based on cost of performance or required that 100% of the sales be apportioned to the state with the greater cost of performance.  Recently, a number of states have adopted market sourcing rules that source sales based on the place of benefit.

When it comes to apportionment the sales factor is usually the most influential factor.  Many states double weight the sales factor and some have adopted a single sales factor apportionment formula.  There is a growing philosophy that by using payroll and property factors for apportionment states are encouraging businesses to build plants and employ workers out of state. 

The complexity of the sales factor is mainly due to the lack of uniform sourcing rules.   In the past, for the most part, sales of services and other then tangible property (OTTP) were sourced based on income-producing activity. If the taxpayer conducted income-producing activities in multiple states the sales were either apportion based on cost of performance or required that 100% of the sales be apportioned to the state with the greater cost of performance.  Recently, a number of states have adopted market sourcing rules that source sales based on the place of benefit. 

First you need to realize that this is a state by state process and that double sourcing and no sourcing of sales may occur. To start you will need to categorize your client’s sales based on the states definitions of tangible and other than tangible property.  This seems like a straight forward process but state’s statutes even differ on these definitions.  For example, when a customer purchases and downloads software, one state may deem the software to be OTTP while another may deem the software to be tangible property.   A business that sells prewritten software delivered electronically in Arkansas and Washington will have OTTP sales in Arkansas and tangible sales in Washington.  Unfortunately, most apportionment statutes do not clearly define tangible property so one must visit the sales and use statutes for more clarity.  If the state is a member of the Streamlined Sales and Use Tax Agreements (SSUTA) you can look to their Taxability Matrix found at: streamlinedsalestax.org. Once the sales have been categorized the sourcing of the sales can be determined by the state’s apportionment statutes.  States’ statues for the sourcing of sales are far from uniform and are riddled with special interest exceptions/elections and some have different sourcing rules for specific businesses.

Ross Inc. has nexus in CA and VA and sells prewritten software that can only be down loaded off the internet.   Ross, Inc. has one office in California where its software developers and project managers work and one office in VA where the executives, administration, business development and sales teams are located.  Customers in VA down loaded $2 million worth of software and customers in CA downloaded a total of $1 million worth of software.

Virginia sale factor: 100%

VA categorizes electronically delivered software as OTTP.  VA sources the sales of OTTP based on where the income-producing activity occurs and if the taxpayer has income-producing activities in more than one state it allocates the entire sale to the state where the majority of the cost of performance occurs (Va. Admin. Code 10-120-230).  In this example 100% of the income producing activities occur in VA.   Ross Inc. sells prewritten software so all its “acts directly engaged in for the ultimate purpose of producing the sale” take place in VA where the sales and business development activities are performed.  In this example Ross Inc.’s sales factor for VA would be 100% (3 Mil/3 Mil).  The development activities in CA are not considered income-producing activities for apportionment since we are dealing with prewritten software vs. custom computer software development services.

California sale factor: 67%

CA categorizes electronically delivered software as OTTP. Starting in 2013 CA will require most businesses to use a single sales apportionment formula.  Sales of OTTP will be sourced based on where the benefit is received by the customer (Cal. Code Regs. 25136-2).  In this situation 2 million in sales will be apportioned to CA and 1 million in sales will be apportioned to VA under CA statutes.  Therefore, the CA sales factor would be 67% (2 mil/3 mil).

It is important to note that if Ross Inc. had its sales and business development teams working out of the CA office they would have sales factors of zero in VA  and 67% in CA.

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Gregory Fallon, EA, MST

Gregory Fallon, EA, MST

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